DISCOVER FINANCIAL SERVICES
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our condensed consolidated
financial statements and related notes included elsewhere in this quarterly
report. This quarterly report contains forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. Such
statements, which speak to our expected business and financial performance,
among other matters, contain words such as "believe," "expect," "anticipate,"
"intend," "plan," "aim," "will," "may," "should," "could," "would," "likely,"
"forecast," and similar expressions. Such statements are based on the current
beliefs and expectations of our management and are subject to significant risks
and uncertainties. Actual results may differ materially from those set forth in
the forward-looking statements. These forward-looking statements speak only as
of the date of this quarterly report and there is no undertaking to update or
revise them as more information becomes available.
The following factors, among others, could cause actual results to differ
materially from those set forth in the forward-looking statements: the effect of
the coronavirus disease 2019 ("COVID-19") pandemic and measures taken to
mitigate the pandemic, including their impact on our credit quality and business
operations as well as their impact on general economic and financial markets,
changes in economic variables, such as the availability of consumer credit, the
housing market, energy costs, the number and size of personal bankruptcy
filings, the rate of unemployment, the levels of consumer confidence and
consumer debt and investor sentiment; the impact of current, pending and future
legislation, regulation, supervisory guidance and regulatory and legal actions,
including, but not limited to, those related to financial regulatory reform,
consumer financial services practices, anti-corruption and funding, capital and
liquidity; the actions and initiatives of current and potential competitors; our
ability to manage our expenses; our ability to successfully achieve card
acceptance across our networks and maintain relationships with network
participants; our ability to sustain and grow our private student loan, personal
loan and home loan products; difficulty obtaining regulatory approval for,
financing, transitioning, integrating or managing the expenses of acquisitions
of or investments in new businesses, products or technologies; our ability to
manage our credit risk, market risk, liquidity risk, operational risk, legal and
compliance risk and strategic risk; the availability and cost of funding and
capital; access to deposit, securitization, equity, debt and credit markets; the
impact of rating agency actions; the level and volatility of equity prices,
commodity prices and interest rates, currency values, investments, other market
fluctuations and other market indices; losses in our investment portfolio;
limits on our ability to pay dividends and repurchase our common stock; limits
on our ability to receive payments from our subsidiaries; fraudulent activities
or material security breaches of key systems; our ability to remain
organizationally effective; our ability to increase or sustain Discover card
usage or attract new customers; our ability to maintain relationships with
merchants; the effect of political, economic and market conditions, geopolitical
events and unforeseen or catastrophic events; our ability to introduce new
products and services; our ability to manage our relationships with third-party
vendors; our ability to maintain current technology and integrate new and
acquired systems; our ability to collect amounts for disputed transactions from
merchants and merchant acquirers; our ability to attract and retain employees;
our ability to protect our reputation and our intellectual property; and new
lawsuits, investigations or similar matters or unanticipated developments
related to current matters. We routinely evaluate and may pursue acquisitions of
or investments in businesses, products, technologies, loan portfolios or
deposits, which may involve payment in cash or our debt or equity securities.
Additional factors that could cause our results to differ materially from those
described below can be found in this section of this quarterly report and in
"Risk Factors," "Business," and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" in our annual report on Form 10-K
for the year ended December 31, 2020 , which is filed with the Securities and
Exchange Commission ("SEC") and available at the SEC's internet site
(https://www.sec.gov).
Introduction and Overview
Discover Financial Services ("DFS") is a digital banking and payment services
company. We provide digital banking products and services and payment services
through our subsidiaries. We offer our customers credit card loans, private
student loans, personal loans, home loans and deposit products. We also operate
the Discover Network, the PULSE network ("PULSE") and Diners Club International
("Diners Club "), collectively known as the Discover Global Network. The Discover
Network processes transactions for Discover-branded credit and debit cards and
provides payment transaction processing and settlement services. PULSE operates
an electronic funds transfer network, providing financial institutions issuing
debit cards on the PULSE network with access to ATMs domestically and
internationally and merchant acceptance throughout the United States for debit
card transactions. Diners Club is a global payments network of licensees, which
are generally financial institutions, that issue Diners Club branded credit and
charge cards and/or provide card acceptance services.
44
--------------------------------------------------------------------------------
Table of Contents
Our primary revenues consist of interest income earned on loan receivables and
fees earned from customers, financial institutions, merchants and issuers. The
primary expenses required to operate our business include funding costs
(interest expense), credit loss provisions, customer rewards and expenses
incurred to grow, manage and service our loan receivables and networks. Our
business activities are funded primarily through consumer deposits,
securitization of loan receivables and the issuance of unsecured debt.
COVID-19 Pandemic Response and Impact
The COVID-19 pandemic has continued to have a widespread and unprecedented
impact on a global scale. While the United States' economy continues to recover
from a brief but severe recession triggered by the COVID-19 pandemic, its future
effects are uncertain and it may be difficult to assess or predict the extent of
the impacts of the pandemic on us as many factors are beyond our control and
knowledge. For a discussion of the risks we face with respect to the COVID-19
pandemic, the associated economic uncertainty, the steps taken to mitigate the
pandemic and the resulting economic contraction, see the risk factors disclosed
in our annual report on Form 10-K for the year ended December 31, 2020 , under
"Risk Factors". This section includes a discussion of the significant areas of
potential impact on us of the COVID-19 pandemic and specific actions we are
taking or expect to take in this time of uncertainty.
Financial Results and Outlook
We saw an increase in sales volume for the three and six months ended June 30,
2021 , compared to the same periods in 2020, as the economy has opened up and
many COVID-19 restrictions have been lifted. Additionally, we decreased our
allowance for credit losses at June 30, 2021 from March 31, 2021 and December
31, 2020 . Refer to "- Loan Quality - Provision and Allowance for Credit Losses"
for more details on the current period allowance for credit losses.
We anticipate modest loan growth in 2021 driven by positive sales trends and new
account growth. We expect net interest margin to remain generally flat relative
to the first quarter of 2021 through the remainder of 2021, with some
variability from quarter to quarter. We expect net charge-offs to be lower
year-over-year driven by continued stable credit performance. We remain
committed to disciplined expense management and will continue to make
investments for profitable long-term growth through increased marketing and
investments in core technology capabilities and efficiency improvements.
Regulatory and Legislative
Federal, state and local governments and independent banking agencies have taken
extraordinary measures to support the United States economy and mitigate the
impacts of the COVID-19 pandemic on the economy and society at large. These
policies have included regulatory relief and flexibility to financial
institutions, liquidity to capital markets and financial support to businesses
and consumers, including fiscal stimulus, payment forbearance, small business
lending programs, increased unemployment payments and other forms of assistance.
Lawmakers continue to offer additional proposals in an attempt to mitigate harm
to the economy and consumers. The effects of these programs are broad and very
complex and depend upon a wide variety of factors, some of which are yet to be
identified. Thus, the ultimate impact of these programs and policies on our
business, results of operations and financial condition is difficult to quantify
and may not be known for some time. For more information, see "- Regulatory
Environment and Developments" below.
Loan Receivables
At the onset of the pandemic, we continued to lend to customers but tightened
our standards for new accounts and for growing existing accounts across all
products in our loan portfolio. As a result of the strong credit performance and
positive economic outlook, we returned most of our underwriting criteria to
pre-pandemic standards during the second quarter of 2021.
In the second quarter of 2021, we decreased our allowance for credit losses in
anticipation of lower credit losses caused by improving macroeconomic forecasts
and continued stable credit performance. Our allowance for credit losses
includes the risk associated with all loans and considers the effects of all
loan modifications, including troubled debt restructurings ("TDRs"), loan
modifications exempt from the TDR designation under the Coronavirus Aid, Relief,
and Economic Security Act ("CARES Act") and Skip-a-Pay (payment deferral)
("SaP") programs. As of June 30, 2021 , the allowance for credit losses took into
account our best estimate for the impact of programs put in place by federal and
state governments and agencies to mitigate the economic impact of the pandemic.
It is unclear whether the measures employed to date are complete or whether
federal and state governments and agencies may take additional actions that
could impact our
45
--------------------------------------------------------------------------------
Table of Contents
business. Refer to "- Loan Quality - Impact of the COVID-19 Pandemic on the Loan
Portfolio" for more details on the current period allowance for credit losses.
Capital and Liquidity
We maintained liquid assets and capital levels in excess of historical norms as
of June 30, 2021 as consumer loan payment rates and deposit balances remain well
above their pre-pandemic levels. Our store of liquid assets has curtailed our
need for wholesale funding, however we maintain good access to all of our
diverse funding channels.
We remain well-capitalized with capital ratios in excess of regulatory minimums
and took prudent actions to preserve and augment our capital when the
macroeconomic and operating environment turned uncertain last year. Our capital
levels allow us to capitalize on loan receivable growth as customers moderate
loan payment rates and spend more as the economy re-opens from the COVID-19
pandemic.
Payment Services
As governments across the world have taken steps to minimize the transmission of
COVID-19, the number of cross-border transactions processed on the Discover
Global Network has declined. Certain negatively impacted categories such as
travel may have an outsized impact on some of our Diners Club franchisees. The
impacts from the COVID-19 pandemic may result in lasting changes in consumer
payment behaviors, such as a shift from credit to debit, a decline in the use of
cash, increasing online sales and rapid adoption of contactless payment. As
economic uncertainty persists, these shifts may continue to result in changes to
the Payment Services segment's results of operations.
Fair Value and Impairments
With the uncertain nature of the pandemic's overall impact on the economy, we
continue to assess the effects of COVID-19 with respect to our goodwill and
intangible assets, investment securities and other long-term assets. For more
information on the impact of COVID-19 pandemic on intangible assets, including
the impairment charge recognized during the three and six months ended June 30,
2021 , see Note 5: Intangible Assets to our condensed consolidated financial
statements.
Business Continuity and Operations
We have re-opened some of our physical locations with appropriate health safety
measures and capacity limitations, including our corporate headquarters.
However, we have informed employees that they may continue to work from home and
will not be required to return to our physical locations prior to September
2021 . Notwithstanding the shift to work-from-home, our operations continue
largely unaffected due to the successful implementation of certain of our
business continuity plans. Operational changes necessitated by the rapid shift
in employee location have not thus far had a material adverse effect on us or
our financial condition; however, the shift has caused us to grow increasingly
dependent on third-party service providers, including those with which we have
no relationship such as our employees' internet service providers. For more
information on the risks associated with reliance on third-party service
providers and the shift to work from home, see the risk factors disclosed in our
annual report on Form 10-K for the year ended December 31, 2020 , under "Risk
Factors".
Regulatory Environment and Developments
As the United States and global economies attempt to normalize from the COVID-19
pandemic, we continue to work with our customers to address their unique
financial situations while balancing safety and soundness requirements. We are
in contact with our regulators and continue to respond to any changing
regulatory guidance, pronouncements and requirements. The federal banking
agencies have taken extraordinary measures to proactively address the economic
disruptions caused by the COVID-19 outbreak and provide flexibility for banking
organizations to work with impacted businesses and consumers. The banking
agencies continue to evaluate whether additional actions are warranted due to
the COVID-19 pandemic. On March 31, 2021 , the Consumer Financial Protection
Bureau ("CFPB") announced it was rescinding several of its policy statements and
withdrawing its participation in several interagency policy statements issued in
response to the COVID-19 pandemic that had been intended to provide flexibility
to financial institutions. The CFPB stated that the rescissions "reflect the
Bureau's commitment to consumer protection and the fact that financial
institutions have had a year to adapt their operations to the difficulties posed
by the pandemic."
In addition, the United States Congress has taken legislative action to address
the economic disruptions caused by the COVID-19 pandemic, including the March
2020 CARES Act and December 2020 Omnibus and COVID Relief and
46
--------------------------------------------------------------------------------
Table of Contents
Response Act. Most recently, the American Rescue Plan of 2021 ("ARPA"), enacted
in March 2021 , contained additional stimulus payments, increased unemployment
benefits and increased small business funding under the Payment Protection
Program. The ARPA also significantly increased and expanded the Child Tax Credit
for one year and provides additional funding for rental assistance programs.
These Congressional efforts offered financial assistance and benefits to
consumers and small businesses. As the pandemic continues into its second year,
additional legislative and regulatory action may be proposed and could include
provisions that significantly impact our prospects and business practices. The
impact of these legislative and regulatory initiatives on our business, the
economy and the United States consumer will depend upon a wide variety of
factors, some of which are yet to be identified.
Banking
Capital Standards and Stress Testing
DFS is subject to mandatory supervisory stress tests every other year and is
required to submit annual capital plans to the Federal Reserve based on
forward-looking internal analysis of income and capital levels under expected
and stressful conditions. DFS is also subject to capital buffer requirements,
including the Stress Capital Buffer ("SCB"), which requires maintenance of
regulatory capital levels above a threshold established based on the results of
supervisory stress tests after accounting for planned dividend payments.
On June 25, 2020 , DFS received results of the Federal Reserve's supervisory
stress tests and preliminary SCB requirements. The notice indicated that DFS'
capital ratios remain above all required minimums under each of the supervisory
scenarios, and based on the stress test results, our preliminary SCB requirement
was set at 3.5%, which was announced as final in a public notice issued by the
Federal Reserve on August 10, 2020 , and will remain in effect until our
preliminary SCB based on the more recent round of stress tests is finalized. In
the June 25, 2020 notice, the Federal Reserve informed DFS that it and all other
firms that participated in the 2020 Comprehensive Capital Analysis and Review
("CCAR") exercise would be required to submit a revised capital plan to be
assessed by the Federal Reserve under newly developed scenarios incorporating
economic stresses reflecting the ongoing COVID-19 pandemic. The Federal Reserve
notified all firms subject to CCAR that they would be subject to temporary
restrictions on capital distributions in the third and fourth quarter of 2020
that restricted most share repurchases and limited dividends based on a formula
that takes into account the firm's average net income over the preceding four
quarters.
On November 2, 2020 , DFS submitted its revised capital plan as part of the CCAR
resubmission process, and the Federal Reserve publicly announced the results of
its analysis on December 18, 2020 . The results indicate that DFS' regulatory
capital ratios remained above all minimum requirements under each of the stress
test scenarios. However, due to ongoing economic uncertainty, the Federal
Reserve extended the temporary restrictions on capital distributions, with
modifications, for all firms subject to the Federal Reserve's capital planning
rule through the second quarter of 2021. On March 25, 2021 , the Federal Reserve
extended the right to recalculate DFS' SCB through June 30, 2021 . Subsequently,
on June 24, 2021 , the Federal Reserve announced that DFS' SCB requirement would
not be recalculated and, effective June 30, 2021 , DFS would be authorized to
make capital distributions that are consistent with the Federal Reserve's
capital rule, inclusive of DFS' final SCB requirement of 3.5% that was
previously announced by the Federal Reserve on August 10, 2020 .
On January 19, 2021 , the Federal Reserve finalized regulatory amendments that
made targeted changes to the capital planning, regulatory reporting and SCB
requirements for firms subject to Category IV standards to be consistent with
the Federal Reserve's regulatory tailoring framework. The final rules generally
align to instructions the Federal Reserve had previously provided to Category IV
firms for recent capital plan submissions. The amended rules also provide
Category IV firms with the option to submit to supervisory stress tests during
off years if they wish to have the stress test portion of their SCB reset. The
Federal Reserve had solicited comments on the need for possible changes to
regulatory guidance related to the capital planning process. In connection with
the final rulemaking, the Federal Reserve revised the scope of application of
its existing regulatory guidance for capital planning to align with the
tailoring framework. However, the timing and substance of any additional changes
to existing guidance or new guidance are uncertain.
On June 24, 2021 , the Federal Reserve publicly announced the results of its
supervisory stress tests for the firms required to participate in the 2021 CCAR
process. Under the recently amended capital plan rule, DFS and other Category IV
firms had the option to elect, at the firm's discretion, to participate in
supervisory stress tests in the 2021 CCAR process. DFS did not elect to
participate this year. Nevertheless, DFS was required to prepare and submit a
capital plan based on a forward-looking internal assessment of income and
capital under baseline and stressful conditions. This plan was submitted by DFS
to the Federal Reserve on April 5, 2021 . The Federal Reserve will use our 2021
capital plan submission to assess its capital planning process and positions
and, if needed, will adjust our SCB requirement to reflect DFS' planned common
stock
47
--------------------------------------------------------------------------------
Table of Contents
dividends. Any such adjustments to DFS' SCB requirement are expected to be
announced and made final by the Federal Reserve in a public notice to be issued
in late August or early September 2021 .
LIBOR
On July 27, 2017 , the UK Financial Conduct Authority ("FCA") announced that it
would no longer encourage or compel banks to continue to contribute quotes and
maintain the London Interbank Offered Rate ("LIBOR") after 2021. On March 5,
2021 , the FCA announced the future cessation and loss of representativeness for
all LIBOR benchmark settings. While non-U.S. Dollar ("USD") and several less
frequently referenced USD LIBOR settings will cease publication immediately
after December 31, 2021 , commonly referenced USD LIBOR settings will cease
publication immediately after June 30, 2023 . To support a smooth transition away
from LIBOR, the Federal Reserve and the Federal Reserve Bank of New York
convened the Alternative Reference Rates Committee ("ARRC"), a group of
private-market participants tasked with ensuring a successful transition from
USD LIBOR to a more robust reference rate. The ARRC identified the Secured
Overnight Financing Rate ("SOFR") as the alternative reference rate for USD
LIBOR. Additionally, the ARRC has established several priorities and milestones
to support the use of SOFR, including developing contractual fallback language
for capital markets and consumer products; providing clarity on legal, tax,
accounting and regulatory matters; and promoting broad outreach and education
efforts around the LIBOR transition.
We have offered and continue to offer floating-rate private student loans based
on LIBOR. As of June 30, 2021 , these loans comprise approximately 43% of our
private student loan portfolio and approximately 5% of our overall loan
portfolio. Our floating-rate borrowings are indexed to LIBOR and limited to
asset-backed securities issued by our securitization trusts. United States
banking regulators have reinforced the need to cease entering into new contracts
that use USD LIBOR as a reference rate after December 31, 2021 . We have a
cross-functional team overseeing and managing our transition away from the use
of LIBOR. This team assesses evolving industry and marketplace norms and
conventions for LIBOR-indexed instruments, evaluates the impacts stemming from
the future cessation of LIBOR publication and facilitates the operational
changes associated with the transition to an alternative reference rate.
Consumer Financial Services
The CFPB regulates consumer financial products and services and examines certain
providers of consumer financial products and services, including Discover. The
CFPB's authority includes preventing "unfair, deceptive or abusive acts or
practices" and ensuring that consumers have access to fair, transparent and
competitive financial products and services. The CFPB has rulemaking,
supervisory and enforcement powers with respect to federal consumer protection
laws. Historically, the CFPB's policy priorities focused on several financial
products of the type we offer (e.g., credit cards and other consumer lending
products). In addition, the CFPB is required by statute to undertake certain
actions, including its biennial review of the consumer credit card market. In
December 2020 , certain of our subsidiaries entered into a consent order with the
CFPB regarding identified private student loan servicing practices. See Note 14:
Litigation and Regulatory Matters to our condensed consolidated financial
statements for more information.
President Biden has nominated Federal Trade Commissioner Rohit Chopra to serve
as the Director of the CFPB . Until the United States Senate confirms Mr. Chopra ,
David Uejio will serve as Acting Director of the CFPB . Under Mr. Chopra's
leadership, the CFPB's priorities are expected to focus on, among other things,
vigorous enforcement of existing consumer protection laws, with a particular
focus on unfair, deceptive and abusive acts and practices, student lending and
servicing, fair lending, debt collection and credit reporting. These changes to
the CFPB's strategies and priorities and any resulting regulatory developments,
findings, potential supervisory or enforcement actions and ratings could
negatively impact our business strategies, require us to limit or change our
business practices, limit our consumer product offerings, invest more management
time and resources in compliance efforts, limit the fees we can charge for
services, or limit our ability to pursue certain business opportunities and
obtain related required regulatory approvals. The additional expense, time and
resources needed to comply with ongoing or new regulatory requirements may
adversely impact the cost of and access to credit and results of business
operations.
Data Security and Privacy
Policymakers at the federal and state levels remain focused on enhancing data
security and data breach incident response requirements. Furthermore,
regulations and legislation at various levels of government have been proposed
and enacted to augment consumer data privacy standards. The California Consumer
Privacy Act ("CCPA") creates a broad set of privacy rights and remedies modeled
in part on the European Union's General Data Protection Regulation. The CCPA
went into effect on January 1, 2020 , and the California Attorney General's final
regulations became effective on August 14, 2020 ,
48
--------------------------------------------------------------------------------
Table of Contents
with enforcement beginning July 1, 2020 . The California Privacy Rights Act
("CPRA"), a ballot measure led by the original proponent of the CCPA, passed on
November 3, 2020 , and largely enters into force on January 1, 2023 . The CPRA
replaces the CCPA to enhance consumer privacy protections further and creates a
new California Privacy Protection Agency . While the CPRA retains an exemption
for information collected, processed, sold, or disclosed subject to the
Gramm-Leach-Bliley Act, we continue to evaluate the impact of the CPRA on our
businesses and other providers of consumer financial services.
Segments
We manage our business activities in two segments, Digital Banking and Payment
Services, based on the products and services provided. For a detailed
description of each segment's operations and the allocation conventions used in
our business segment reporting, see Note 17: Segment Disclosures to our
condensed consolidated financial statements.
The following table presents segment data (dollars in millions):
For the Three Months Ended For the Six Months Ended June
June 30, 30,
2021 2020 2021 2020
Digital Banking
Interest income
Credit card loans $ 2,105 $ 2,173 $ 4,259 $ 4,589
Private student loans 184 182 370 387
Personal loans 219 231 442 485
Other loans 28 27 56 51
Other interest income 53 59 108 142
Total interest income 2,589 2,672 5,235 5,654
Interest expense 290 482 606 1,066
Net interest income 2,299 2,190 4,629 4,588
Provision for credit losses 135 2,046 (230) 3,853
Other income 458 354 837 720
Other expense 1,092 982 2,139 2,100
Income (loss) before income taxes 1,530 (484) 3,557 (645)
Payment Services
Other income 822 118 908 242
Other expense 130 95 164 136
Income before income taxes 692 23 744 106
Total income (loss) before income taxes $ 2,222 $
(461)
49--------------------------------------------------------------------------------
Table of Contents
The following table presents information on transaction volume (dollars in
millions):
For the Three Months Ended June For the Six Months Ended June
30, 30,
2021 2020 2021 2020
Network Transaction Volume
PULSE Network $ 62,855 $ 52,859 $ 123,254 $ 102,033
Network Partners 9,468 7,280 19,097 14,260
Diners Club(1) 6,126 4,339 12,023 12,076
Total Payment Services 78,449 64,478 154,374 128,369
Discover Network-Proprietary(2) 47,201 32,349 86,403 67,529
Total Network Transaction Volume $ 125,650
799 565 1,477 1,210
PULSE Network 1,399 1,209 2,709 2,398
Total Transactions Processed on Networks 2,198 1,774 4,186 3,608
Credit Card Volume
Discover Card Volume(3) $ 48,049 $ 33,105 $ 88,383 $ 70,579
Discover Card Sales Volume(4) $ 45,460 $ 30,721 $ 83,204 $ 64,709
(1)Diners Club volume is derived from data provided by licensees for Diners Club
branded cards issued outside North America and is subject to subsequent revision
or amendment.
(2)Represents gross Discover card sales volume on the Discover Network.
(3)Represents Discover card activity related to sales net of returns, balance
transfers, cash advances and other activities
(4)Represents Discover card activity related to sales net of returns.
Digital Banking
Our Digital Banking segment reported pretax income of $1.5 billion and $3.6
billion , respectively, for the three and six months ended June 30, 2021 , as
compared to a pretax loss of $484 million and $645 million , respectively, for
the three and six months ended June 30, 2020 .
Net interest income increased for the three and six months ended June 30, 2021 ,
as compared to the same periods in 2020, primarily driven by lower funding
costs, partially offset by a lower average level of outstanding loan
receivables. Interest income decreased during the three and six months ended
June 30, 2021 , as compared to the same periods in 2020. This decrease was
primarily due to a lower average level of outstanding credit card loan
receivables. Interest expense decreased during the three and six months ended
June 30, 2021 , as compared to the same periods in 2020 due to lower average
market rates, a lower funding base, lower pricing on deposits and higher coupon
maturities.
For the three and six months ended June 30, 2021 , the provision for credit
losses decreased as compared to the same periods in 2020, primarily due to
reserve releases in the current periods versus reserve build in the prior
periods and lower net charge-offs. The release during the three and six months
ended June 30, 2021 , was driven by improvements in the macroeconomic forecast,
continued stable credit performance and a reduction in loan receivables
outstanding. For a detailed discussion on provision for credit losses, see "-
Loan Quality - Provision and Allowance for Credit Losses."
Total other income increased for the three and six months ended June 30, 2021 ,
as compared to the same periods in 2020, which was primarily due to an increase
in discount and interchange revenue. The increase in discount and interchange
revenue was partially offset by an increase in rewards costs, both of which were
the result of higher sales volume during the period.
Total other expense increased for the three months ended June 30, 2021 , as
compared to the same period in 2020, primarily due to increases in employee
compensation and benefits, marketing and business development and information
processing and communications. Employee compensation and benefits increased as a
result of higher bonus accruals and higher average salaries, partially offset by
lower headcount. Marketing and business development increased due to accelerated
growth investments primarily in card. Information processing and communications
increased due to software write-offs.
Total other expense increased for the six months ended June 30, 2021 , as
compared to the same period in 2020, primarily due to an increase in employee
compensation and benefits, partially offset by a decrease in marketing and
business
50
--------------------------------------------------------------------------------
Table of Contents
development. Employee compensation and benefits increased as a result of higher
bonus accruals and higher average salaries, partially offset by lower headcount.
Marketing costs decreased primarily due to expense reductions in acquisition and
brand advertising for card during the first quarter of 2021.
Discover card sales volume was $45.5 billion and $83.2 billion , respectively,
for the three and six months ended June 30, 2021 , which was an increase of 48.0%
and 28.6%, respectively, as compared to the same periods in 2020. This volume
growth was primarily driven by higher consumer spending.
Payment Services
Our Payment Services segment reported pretax income of $692 million and $744
million , respectively, for the three and six months ended June 30, 2021 , as
compared to pretax income of $23 million and $106 million for the same periods
in 2020. In June 2021 , a payment services entity in which we hold a
non-controlling equity position completed its initial public offering, at which
time we began carrying the investment at fair value. The fair value adjustment
resulted in the recognition of a $729 million unrealized gain. Total other
expense for the Payment Services segment increased due to an incremental
non-cash impairment charge of Diners Club intangible assets for the three and
six months ended June 30, 2021 .
Critical Accounting Estimates
In preparing our condensed consolidated financial statements in conformity with
accounting principles generally accepted in the United States ("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 economic or market conditions changes, 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 condensed consolidated financial statements are appropriate.
However, if actual experience differs from the assumptions and other
considerations used in estimating amounts in our condensed consolidated
financial statements, the resulting changes could have a material effect on our
consolidated results of operations and, in some instances, could have a material
effect on our consolidated financial condition. Management has identified the
estimate related to our allowance for credit losses as a critical accounting
estimate. The critical accounting estimate related to the allowance for credit
losses is discussed in greater detail in our annual report on Form 10-K for the
year ended December 31, 2020 , under "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Critical Accounting Estimates".
There have not been any material changes in the methods used to formulate this
critical accounting estimate from those discussed in our annual report on Form
10-K for the year ended December 31, 2020 .
Earnings Summary
The following table outlines changes in our condensed consolidated statements of
income (dollars in millions):
For the Three Months Ended 2021 vs. 2020 For the Six Months Ended June 2021 vs. 2020
June 30, (Decrease) Increase 30, (Decrease) Increase
2021 2020 $ % 2021 2020 $ %
Interest income $ 2,589 $ 2,672 $ (83) (3) % $ 5,235 $ 5,654 $ (419) (7) %
Interest expense 290 482 (192) (40) % 606 1,066 (460) (43) %
Net interest income 2,299 2,190 109 5 % 4,629 4,588 41 1 %
Provision for credit losses 135 2,046 (1,911) (93) % (230) 3,853 (4,083) (106) %
Net interest income after
provision for credit losses 2,164 144 2,020 1,403 % 4,859 735 4,124 561 %
Other income 1,280 472 808 171 % 1,745 962 783 81 %
Other expense 1,222 1,077 145 13 % 2,303 2,236 67 3 %
Income (loss) before income
taxes 2,222 (461) 2,683 NM 4,301 (539) 4,840 NM
Income tax expense (benefit) 524 (93) 617 NM 1,010 (110) 1,120 NM
Net income (loss) $ 1,698 $ (368) $ 2,066 NM $ 3,291 $ (429) $ 3,720 NM
51-------------------------------------------------------------------------------- Table of Contents Net Interest Income The table that follows this section has been provided to supplement the discussion below and provide further analysis of net interest income and net interest margin. 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. The following factors influence net interest income: •The level and composition of loan receivables, including the proportion of credit card loans to other loans, as well as the proportion of loan receivables bearing interest at promotional rates as compared to standard rates; •The credit performance of our loans, particularly with regard to charge-offs of finance charges, which reduce interest income; •The terms of long-term borrowings and certificates of deposit upon initial offering, including maturity and interest rate; •The interest rates necessary to attract and maintain direct-to-consumer deposits; •The level and composition of other interest-earning assets, including our liquidity portfolio and interest-bearing liabilities; •Changes in the interest rate environment, including the levels of interest rates and the relationships among interest rate indices, such as the prime rate, the Federal Funds rate, interest rate on excess reserves and LIBOR; and •The effectiveness of interest rate swaps in our interest rate risk management program. Net interest income increased for the three and six months endedJune 30, 2021 , as compared to the same periods in 2020, primarily driven by lower funding costs, partially offset by a lower average level of outstanding loan receivables. Interest income decreased during the three and six months endedJune 30, 2021 , as compared to the same periods in 2020. This decrease was primarily due to a lower average level of outstanding credit card loan receivables. Interest expense decreased during the three and six months endedJune 30, 2021 , as compared to the same periods in 2020 due to lower average market rates, a lower funding base, lower pricing on deposits and higher coupon maturities. 52 -------------------------------------------------------------------------------- Table of Contents Average Balance Sheet Analysis (dollars in millions) For the Three Months Ended June 30, 2021 2020 Average Average Balance Yield/Rate Interest Balance Yield/Rate Interest Assets Interest-earning assets Cash and cash equivalents$ 17,562 0.11 %$ 6 $ 14,655 0.11 %$ 5 Restricted cash 897 0.02 % NM 226 0.25 % NM Other short-term investments - - % - 440 0.15 % NM Investment securities 9,222 2.06 % 47 10,586 2.12 % 55 Loan receivables(1) Credit card loans(2) 67,420 12.52 % 2,105 70,848 12.34 % 2,173 Private student loans 9,993 7.41 % 184 9,826 7.46 % 182 Personal loans 6,884 12.76 % 219 7,475 12.40 % 231 Other loans 1,999 5.59 % 28 1,622 6.49 % 26 Total loan receivables 86,296 11.79 % 2,536 89,771 11.70 % 2,612 Total interest-earning assets 113,977 9.11 % 2,589 115,678 9.29 % 2,672 Allowance for credit losses (7,342) (6,927) Other assets 5,971 5,717 Total assets$ 112,606 $ 114,468 Liabilities and Stockholders' Equity Interest-bearing liabilities Interest-bearing deposits Time deposits$ 24,772 1.89 % 116$ 33,993 2.46 % 208 Money market deposits(3) 8,199 0.53 % 11 7,717 1.22 % 24 Other interest-bearing savings deposits 41,073 0.42 % 43 33,532 1.30 %
108
Total interest-bearing deposits 74,044 0.92 % 170 75,242 1.81 % 340 Borrowings Securitized borrowings(4)(5) 10,305 1.01 % 26 12,960 1.24 % 39 Other long-term borrowings(5) 10,211 3.66 % 94 11,375 3.63 % 103 Total borrowings 20,516 2.33 % 120 24,335 2.36 % 142 Total interest-bearing liabilities 94,560 1.23 % 290 99,577 1.95 %
482
Other liabilities and stockholders' equity 18,046 14,891 Total liabilities and stockholders' equity$ 112,606 $ 114,468 Net interest income$ 2,299 $ 2,190 Net interest margin(6) 10.68 % 9.81 % Net yield on interest-earning assets(7) 8.09 % 7.61 % Interest rate spread(8) 7.88 % 7.34 % 53
--------------------------------------------------------------------------------
Table of Contents
For the Six Months Ended June 30,
2021 2020
Average Average
Balance Yield/Rate Interest Balance Yield/Rate Interest
Assets
Interest-earning assets
Cash and cash equivalents $ 17,521 0.11 % $ 11 $ 11,002 0.49 % $ 27
Restricted cash 519 0.03 % NM 427 0.85 % 2
Other short-term investments 354 0.12 % NM 220 0.15 % NM
Investment securities 9,478 2.07 % 97 10,607 2.15 % 113
Loan receivables(1)
Credit card loans(2) 68,068 12.62 % 4,259 73,092 12.63 % 4,589
Private student loans 10,101 7.39 % 370 9,909 7.85 % 387
Personal loans 6,979 12.79 % 442 7,589 12.84 % 485
Other loans 1,948 5.76 % 56 1,545 6.60 % 51
Total loan receivables 87,096 11.87 % 5,127 92,135 12.03 % 5,512
Total interest-earning assets 114,968 9.18 % 5,235 114,391 9.94 % 5,654
Allowance for credit losses (7,776) (6,389)
Other assets 6,067 5,689
Total assets $ 113,259 $ 113,691
Liabilities and Stockholders' Equity
Interest-bearing liabilities
Interest-bearing deposits
Time deposits $ 25,899 1.97 % 253 $ 33,778 2.52 % 423
Money market deposits(3) 8,173 0.53 % 21 7,397 1.46 % 54
Other interest-bearing savings deposits 40,608 0.44 % 89 32,435 1.47 % 236
Total interest-bearing deposits 74,680 0.98 % 363 73,610 1.95 % 713 Borrowings Securitized borrowings(4)(5) 10,565 1.04 % 54 13,524 1.78 % 120 Other long-term borrowings(5) 10,285 3.69 % 189 11,582 4.05 % 233 Total borrowings 20,850 2.35 % 243 25,106 2.83 % 353 Total interest-bearing liabilities 95,530 1.28 % 606 98,716 2.17 %
1,066
Other liabilities and stockholders' equity 17,729 14,975 Total liabilities and stockholders' equity$ 113,259 $ 113,691 Net interest income$ 4,629 $ 4,588 Net interest margin(6) 10.72 % 10.01 % Net yield on interest-earning assets(7) 8.12 % 8.07 % Interest rate spread(8) 7.90 % 7.77 % (1)Average balances of loan receivables and yield calculations include non-accruing loans. If the non-accruing loan balances were excluded, there would not be a material impact on the amounts reported above. (2)Interest income on credit card loans includes$71 million and$76 million of amortization of balance transfer fees for the three months endedJune 30, 2021 and 2020, respectively, and$144 million and$158 million for the six months endedJune 30, 2021 and 2020, respectively. (3)Includes the impact of interest rate swap agreements used to change a portion of floating-rate funding to fixed-rate funding for the three and six months endedJune 30, 2020 . (4)Includes the impact of one terminated derivative formerly designated as a cash flow hedge for the three and six months endedJune 30, 2021 and 2020. (5)Includes the impact of interest rate swap agreements used to change a portion of fixed-rate funding to floating-rate funding for the three and six months endedJune 30, 2021 and 2020. (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 total interest-bearing liabilities. 54 -------------------------------------------------------------------------------- Table of Contents Loan Quality Impact of the COVID-19 Pandemic on the Loan Portfolio The COVID-19 pandemic and its impact on the economy have significantly affected our sales volume and credit card loan growth. We tightened standards for new accounts and for growing existing accounts across all products at the onset of the pandemic. Due to the strong economic recovery from the COVID-19 pandemic-induced recession, we returned most of our underwriting criteria to pre-pandemic standards during the second quarter of 2021. This change in our credit underwriting, in addition to changes in consumer spending behavior, increased marketing and the re-opening ofthe United States economy upon expiration of COVID-19 restrictions, contributed to an increase in sales volume for the three and six months endedJune 30, 2021 , when compared to the same periods in 2020. Our outstanding loan receivables as ofJune 30, 2021 , decreased when compared toDecember 31, 2020 , due to elevated payment rates resulting from the several rounds of government stimulus and associated improvement in household cash flows. The decrease in outstanding loan receivables was partially offset by positive sales trends in the first and second quarters of 2021. At the onset of the COVID-19 pandemic, we expanded borrower relief offerings to include SaP and other loan modification programs, complementing the assistance already available through our existing loan modification programs. OnAugust 31, 2020 , we ceased offering enrollments in the SaP and other loan modification programs specifically developed in response to the COVID-19 pandemic. The accounts using these modifications as a result of the COVID-19 pandemic were evaluated for potential exclusion from the TDR designation either due to the insignificance of the concession or because they qualified for an exemption pursuant to the CARES Act. The SaP programs provided only an insignificant delay in payment on the enrolled accounts or loans and therefore those deferrals were not classified as TDRs Section 4013 of the CARES Act provides certain financial institutions with the option to suspend the application of accounting and reporting guidance for TDRs for a limited period of time for loan modifications made to address the effects of the COVID-19 pandemic. Section 541 of the Omnibus and COVID Relief and Response Act extended the TDR accounting and reporting relief provided by the CARES Act through the earlier ofJanuary 1, 2022 , or the date that is 60 days after the termination of the presidentially-declared national emergency. We elected to apply the option to suspend the application of accounting and reporting guidance for TDRs as provided under Section 4013 of the CARES Act and as subsequently extended. As such, the number of accounts and corresponding balances designated as a TDR for the three and six months endedJune 30, 2021 and 2020, have been favorably impacted by the exclusion of certain modifications from the TDR designation pursuant to these exemptions and are expected to remain lower than they otherwise would have been. The payment status of modified accounts excluded from the TDR designation pursuant to the CARES Act is reflected in our delinquency reporting. 55 -------------------------------------------------------------------------------- Table of Contents The table below reflects the number and balance of both new loan modifications reported as TDRs and new loan modifications excluded from the TDR designation pursuant to the CARES Act (dollars in millions)(1): Accounts that entered a loan Accounts that entered a loan modification program and were exempt modification program and were from the TDR designation pursuant to classified as TDRs during the period the CARES Act(1) Number of Number of Accounts Balances Accounts Balances For the Three Months EndedJune 30, 2021 Credit card loans 14,221$ 94 23,983$ 177 Private student loans 127$ 3 2,666$ 50 Personal loans 824$ 11 261$ 4 For the Three Months EndedJune 30, 2020 (2) Credit card loans 27,966$ 192 61,097$ 468 Private student loans 62$ 1 1,363$ 24 Personal loans 1,332$ 17 168$ 3 For the Six Months EndedJune 30, 2021 (3) Credit card loans 34,923$ 229 69,524$ 497 Private student loans 253$ 5 4,713$ 89 Personal loans 2,214$ 28 938$ 15 For the Six Months EndedJune 30, 2020 (3) Credit card loans 110,090$ 725 75,020$ 578 Private student loans 1,649$ 30 1,494$ 27 Personal loans 3,810$ 50 238$ 4 (1)SaP programs were not considered TDRs and therefore are not included in accounts excluded from the TDR designation by the CARES Act. (2)Certain prior period amounts have been reclassified to conform to the current period presentation. (3)As the TDR exemption pursuant to the CARES Act took effect inMarch 2020 , the six months endedJune 30, 2021 , is not comparable to the same period in 2020. The number and balance of new credit card and personal loan modifications, including the combined total of those identified as TDRs and those exempt from the TDR designation, decreased during the three and six months endedJune 30, 2021 , when compared to the same periods in 2020. The decrease in both periods is due to the impacts of government stimulus and government-mandated disaster relief programs. The number and balance of all loan modifications, including the combined total of those identified as TDRs and those exempt from the TDR designation, during the three and six months endedJune 30, 2020 were favorably impacted by the utilization of SaP programs in lieu of traditional loan modification programs. Additionally, enrollments in personal loan modification programs were favorably impacted by tighter underwriting standards that were implemented before the COVID-19 pandemic. 56 -------------------------------------------------------------------------------- Table of Contents The following table provides the number of accounts that exited a temporary loan modification program that were exempt from the TDR designation pursuant to the CARES Act and corresponding outstanding balances along with the amount of the outstanding balances that were delinquent (30 or more days past due) upon exiting the temporary loan modification program (dollars in millions)(1):
Three Months Ended
Number of Outstanding Balances
Accounts Balances Delinquent(2)
Credit card loans 54,066 $ 320 $ 44
Private student loans(3) 1,876 $ 34 NM
Personal loans(3) 1,406 $ 19 NM
Six Months Ended
Number of Outstanding Balances
Accounts Balances Delinquent(2)
Credit card loans 113,645 $ 701 $ 94
Private student loans(3) 3,734 $ 66 NM
Personal loans(3) 2,794 $ 40 NM
(1)As the TDR exemption pursuant to the CARES Act took effect in March 2020 , the
six months ended June 30, 2021 , is not comparable to the same period in 2020.
The number of accounts that exited a temporary loan modification program that
were exempt from the TDR designation pursuant to the CARES Act and corresponding
outstanding balances were not meaningful for the three and six months ended June
30, 2020 .
(2)Includes balances charged off at the end of the month the account exited the
temporary loan modification program. The balances charged off were not
meaningful for the three and six months ended June 30, 2021 and 2020.
(3)The private student loan and personal loan balances that were delinquent upon
exiting a temporary loan modification program were not meaningful for the three
and six months ended June 30, 2021 and 2020.
Our estimate of expected loss reflected in our allowance for credit losses
includes the risk associated with all loans. We consider the effects of all loan
modifications, including TDRs, loan modifications exempt from the TDR
designation pursuant to the CARES Act and SaP programs. We believe we have
appropriately reflected the risk of the accounts using these programs and the
economic impact of the COVID-19 pandemic on our customers in the allowance for
credit losses. Refer to Note 3: Loan Receivables to our condensed consolidated
financial statements for more details on modification programs, TDRs and the
allowance for credit losses.
Loan receivables consist of the following (dollars in millions):
June 30,
2021 December 31, 2020
Credit card loans $ 68,886 $ 71,472
Other loans
Private student loans 9,864 9,954
Personal loans 6,865 7,177
Other loans 2,059 1,846
Total other loans 18,788 18,977
Total loan receivables 87,674 90,449
Allowance for credit losses (7,026) (8,226)
Net loan receivables $ 80,648 $ 82,223
57-------------------------------------------------------------------------------- Table of Contents Provision and Allowance for Credit Losses Provision for credit losses is the expense related to maintaining the allowance for credit losses at an appropriate level to absorb the estimate of credit losses anticipated over the remaining expected life of loan receivables at each period end date. In deriving the estimate of expected credit loss, we consider the collectability of principal, interest and fees associated with our loan receivables. We also consider expected recoveries of amounts that were either previously charged off or are expected to be charged off. Establishing the estimate for expected credit losses requires significant management judgment. The factors that influence the provision for credit losses include: •Increases or decreases in outstanding loan balances, including: •Changes in consumer spending, payment and credit utilization behaviors; •The level of originations and maturities; and •Changes in the overall mix of accounts and products within the portfolio; •The credit quality of the loan portfolio, which reflects our credit granting practices and the effectiveness of collection efforts, among other factors; •The impact of general economic conditions on the consumer, including national and regional conditions, unemployment levels, bankruptcy trends and interest rate movements; •The level and direction of historical losses; and •Regulatory changes or new regulatory guidance. Refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates" in our annual report on Form 10-K for the year endedDecember 31, 2020 , and Note 3: Loan Receivables to our condensed consolidated financial statements for more details on how we estimate the allowance for credit losses. 58 -------------------------------------------------------------------------------- Table of Contents The following tables provide changes in our allowance for credit losses (dollars in millions):
For the Three Months Ended
Credit Card Private
Loans Student Loans Personal Loans Other Loans Total Loans
Balance at March 31, 2021 $ 5,640 $ 862 $ 804 $ 41 $ 7,347 Additions
Provision for credit losses(1) 181 (21) (28) 3 135 Deductions Charge-offs (620) (20) (48) - (688) Recoveries 208 7 17 - 232 Net charge-offs (412) (13) (31) - (456) Balance at June 30, 2021$ 5,409 $ 828 $ 745 $ 44$ 7,026
For the Three Months Ended
Credit Card Private
Loans Student Loans Personal Loans Other Loans Total Loans
Balance at March 31, 2020 $ 5,306 $ 765 $ 807 $ 35 $ 6,913 Additions
Provision for credit losses(1) 1,873 49 114 2 2,038 Deductions Charge-offs (852) (20) (78) - (950) Recoveries 164 5 14 - 183 Net charge-offs (688) (15) (64) - (767) Balance at June 30, 2020$ 6,491 $ 799 $ 857 $ 37$ 8,184
For the Six Months Ended
Credit Card Private
Loans Student Loans Personal Loans Other Loans Total Loans
Balance at December 31, 2020 $ 6,491 $ 840 $ 857 $ 38 $ 8,226 Additions
Provision for credit losses(1) (196) 15 (32) 6 (207) Deductions Charge-offs (1,283) (40) (112) - (1,435) Recoveries 397 13 32 - 442 Net charge-offs (886) (27) (80) - (993) Balance at June 30, 2021$ 5,409 $ 828 $ 745 $ 44$ 7,026
For the Six Months Ended
Credit Card Private
Loans Student Loans Personal Loans Other Loans Total Loans
Balance at December 31, 2019(2) $ 2,883 $ 148 $ 348 $ 4 $ 3,383
Cumulative effect of ASU No. 2016-13
adoption(3) 1,667 505 265 24 2,461
Balance at January 1, 2020 4,550 653 613 28 5,844
Additions
Provision for credit losses(2) 3,312 178 377 9 3,876 Deductions Charge-offs (1,721) (42) (162) - (1,925) Recoveries 350 10 29 - 389 Net charge-offs (1,371) (32) (133) - (1,536) Balance at June 30, 2020)$ 6,491 $ 799 $ 857 $ 37$ 8,184 (1)Excludes an$8 million reclassification of the liability for expected credit losses on unfunded commitments for the three months endedJune 30, 2020 , and$23 million for the six months endedJune 30, 2021 and 2020, as the liability is recorded in accrued expenses and other liabilities in our condensed consolidated statements of financial condition. (2)Prior to the adoption of ASU No. 2016-13 onJanuary 1, 2020 , credit losses were estimated using the incurred loss approach. (3)Represents the adjustment to the allowance for credit losses due to the adoption of ASU No. 2016-13 onJanuary 1, 2020 . 59 -------------------------------------------------------------------------------- Table of Contents The allowance for credit losses was$7.0 billion atJune 30, 2021 , which reflects a$321 million release from the amount of the allowance for credit losses atMarch 31, 2021 and a$1.2 billion release from the amount of the allowance for credit losses atDecember 31, 2020 . The release in the allowance for credit losses betweenJune 30, 2021 andMarch 31, 2021 , was primarily driven by improving macroeconomic forecasts and continued stable credit performance, partially offset by modest loan growth during the period. The modest growth in loan receivables during the three months endedJune 30, 2021 , was driven by the positive sales trends as COVID-19 restrictions expire andthe United States' economy reopens. The loan growth was partially offset by elevated payment rates resulting from the several rounds of government stimulus and associated improvement in household cash flows. In estimating expected credit losses, we considered the uncertainties associated with borrower behavior, payment trends and credit performance subsequent to the expiration of government stimulus programs, such as the CARES Act and ARPA, and government-mandated disaster relief programs, such as foreclosure moratoriums and federal student loan and mortgage payment forbearance. The release in the allowance for credit losses betweenJune 30, 2021 andDecember 31, 2020 , was primarily driven by improvements in the macroeconomic forecast, continued stable credit performance and a reduction in loan receivables outstanding during the period. The decrease in outstanding loan receivables, particularly credit card loan receivables, and the stable credit performance, were driven in part by elevated payment rates resulting from the several rounds of government stimulus and associated improvement in household cash flows. The decrease in outstanding loan receivables was partially offset by positive sales trends in the first and second quarters of 2021. In estimating the allowance atJune 30, 2021 , we used a macroeconomic forecast that projected (i) a peak unemployment rate of 6.4%, which decreases to 5.5% through the end of 2021, and (ii) a 6.7% growth in the real gross domestic product in 2021. Labor market conditions, which historically have been an important determinant of our credit loss trends, have improved but the unemployment rate and initial and continuing jobless claims remain elevated relative to pre-pandemic levels. Moreover, as the government's response to the pandemic wanes, there is uncertainty regarding the sustainability of the recent credit quality trends in our receivables portfolio. Accordingly, the estimation of the allowance for credit losses has required significant management judgment. The forecast period we deemed reasonable and supportable was 18 months for all periods presented exceptMarch 31, 2020 , where the forecast period was 12 months due to the uncertainty caused by the rapidly changing economic environment experienced at the onset of the COVID-19 pandemic. The 18-month reasonable and supportable forecast period was deemed appropriate based on the observed stabilization of macroeconomic forecasts. For all periods presented, we determined that a reversion period of 12 months was appropriate. Due to the uncertainties associated with borrower behavior resulting from government stimulus and government-mandated disaster relief programs, we applied a weighted reversion method to provide a more reasonable transition to historical losses for all loan products for all periods presented with the following exceptions: atMarch 31, 2020 andDecember 31, 2019 , we applied a straight-line method for all loan products. AtJune 30, 2020 , we applied a weighted reversion method for credit card loans and a straight-line method for all other loan products. The provision for credit losses is the amount of expense realized after considering the level of net charge-offs in the period and the required amount of allowance for credit losses at the balance sheet date. For the three months endedJune 30, 2021 , the provision for credit losses decreased by$1.9 billion , or 93%, compared to the same period in 2020. For the six months endedJune 30, 2021 , the provision for credit losses decreased by$4.1 billion , or 105%, compared to the same period in 2020. The decrease in both periods was primarily due to reserve releases in the current periods versus reserve builds in the prior periods and lower net charge-offs. The reserve releases during the three and six months endedJune 30, 2021 , were primarily driven by a favorable change in the macroeconomic outlook related to the economic impacts of the COVID-19 pandemic-induced recession, continued stable credit performance and the reduction in loan receivables outstanding during the period. The reserve builds during the three and six months endedJune 30, 2020 , were primarily due to the unfavorable change in economic outlook resulting from the COVID-19 pandemic. 60 -------------------------------------------------------------------------------- Table of Contents Net Charge-offs Our net charge-offs include the principal amount of losses charged off less principal recoveries and exclude charged-off and recovered interest and fees and fraud losses. Charged-off and recovered interest and fees are recorded in interest income and loan fee income, respectively, which is effectively a reclassification of the provision for credit losses, while fraud losses are recorded in other expense. The following table presents amounts and rates of net charge-offs of key loan products (dollars in millions): For the Three Months Ended June 30, For the Six Months Ended June 30, 2021 2020 2021 2020 $ % $ % $ % $ % Credit card loans$ 412 2.45 %$ 688 3.90 %$ 886 2.63 %$ 1,371 3.77 % Private student loans$ 13 0.53 %$ 15 0.62 %$ 27 0.53 %$ 32 0.65 % Personal loans$ 31 1.80 %$ 64 3.43 %$ 80 2.30 %$ 133 3.51 % The decrease in net charge-offs and the net charge-off rates across all loan products for the three and six months endedJune 30, 2021 , when compared to the same periods in 2020, were primarily due to the impacts of government stimulus and government-mandated disaster relief programs. Additionally, net charge-offs and the net charge-off rate for personal loans were favorably impacted by tighter underwriting standards that were implemented before the COVID-19 pandemic. 61 -------------------------------------------------------------------------------- Table of Contents 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 loans restructured in TDR programs (dollars in millions): June 30, 2021
$ % $ %
Loans 30 or more days delinquent
Credit card loans $ 983 1.43 % $ 1,478 2.07 %
Private student loans $ 132 1.34 % $ 138 1.39 %
Personal loans $ 47 0.69 % $ 78 1.08 %
Loans 90 or more days delinquent(1)
Credit card loans $ 504 0.73 % $ 739 1.03 %
Private student loans $ 28 0.29 % $ 28 0.28 %
Personal loans $ 13 0.19 % $ 25 0.35 %
Loans not accruing interest $ 219 0.23 % $ 243 0.26 %
Troubled debt restructurings:
Credit card loans(2)(3)(4)
Currently enrolled $ 945 1.37 % $ 1,225 1.71 %
No longer enrolled 349 0.51 448 0.63
Total credit card loans $ 1,294 1.88 % $ 1,673 2.34 %
Private student loans(5) $ 267 2.71 % $ 286 2.87 %
Personal loans(6) $ 206 3.00 % $ 222 3.09 %
(1)Credit card loans that were 90 or more days delinquent at June 30, 2021 and
December 31, 2020 , included $53 million and $44 million , respectively, in
modified loans exempt from the TDR designation under the CARES Act. Within
private student and personal loans that were 90 or more days delinquent at
June 30, 2021 and December 31, 2020 , the respective amounts associated with
modifications exempt from the TDR designation under the CARES Act were
immaterial.
(2)We estimate that interest income recognized on credit card loans restructured
in TDR programs was $27 million and $60 million for the three months ended June
30, 2021 and 2020, respectively, and $60 million and $131 million for the six
months ended June 30, 2021 and 2020, respectively. We do not separately track
interest income on loans in TDR programs. We estimate this amount by applying an
average interest rate to the average loans in the various TDR programs.
(3)We estimate that the incremental interest income that would have been
recorded in accordance with the original terms of credit card loans restructured
in TDR programs was $35 million and $47 million for the three months ended June
30, 2021 and 2020, respectively, and $72 million and $101 million for the six
months ended June 30, 2021 and 2020, respectively. We do not separately track
the amount of incremental interest income that would have been recorded if the
loans in TDR programs had not been restructured and interest had instead been
recorded in accordance with the original terms. We estimate this amount by
applying the difference between the average interest rate earned on non-modified
loans and the average interest rate earned on loans in the TDR programs to the
average loans in the TDR programs.
(4)Credit card loans restructured in TDR programs include $55 million and $94
million at June 30, 2021 and December 31, 2020 , respectively, which are also
included in loans 90 or more days delinquent.
(5)Private student loans restructured in TDR programs include $6 million at
June 30, 2021 and December 31, 2020 , which are also included in loans 90 or more
days delinquent.
(6)Personal loans restructured in TDR programs include $4 million and $6 million
at June 30, 2021 and December 31, 2020 , respectively, which are also included in
loans 90 or more days delinquent.
The 30-day and 90-day delinquency rates in the table above include all loans,
including TDRs, modified loans exempt from TDR status and prior modifications,
which are no longer required to be reported as TDRs. The 30-day and 90-day
delinquency rates for credit card and personal loans at June 30, 2021 , decreased
compared to December 31, 2020 , primarily due to the impacts of government
stimulus and government-mandated disaster relief programs. Additionally, the
30-day and 90-day delinquency rates for personal loans were favorably impacted
by tighter underwriting standards that were implemented before the COVID-19
pandemic. The 30-day and 90-day delinquency rate for private student loans at
June 30, 2021 , was essentially flat compared to December 31, 2020 .
The balance of private student and credit card loans reported as TDRs decreased
at June 30, 2021 , compared to December 31, 2020 , primarily due to the exclusion
of accounts qualifying for the exemption from the TDR designation pursuant to
the CARES Act and elevated payment rates resulting from the several rounds of
government stimulus and associated improvement in household cash flows.
62
--------------------------------------------------------------------------------
Table of Contents
The balance of personal loans reported as TDRs decreased at June 30, 2021 ,
compared to December 31, 2020 , due to elevated payment rates resulting from the
several rounds of government stimulus and associated improvement in household
cash flows. To provide additional clarity with respect to credit card loans
classified as TDRs, the table above presents loans that are currently enrolled
in modification programs separately from loans that have exited those programs
but retain that classification.
The following table provides the balance of loan receivables restructured
through a temporary loan modification program that were exempt from the TDR
designation pursuant to the CARES Act (dollars in millions):
June 30, 2021 December 31, 2020
$ % $ %
Credit card loans $ 1,484 2.16 % $ 1,351 1.89 %
Private student loans $ 180 1.82 % $ 101 1.01 %
Personal loans $ 64 0.93 % $ 73 1.02 %
We believe loan modification programs are useful in assisting customers
experiencing financial difficulties and help to prevent defaults. We plan to
continue to use loan modification programs as a means to provide relief to
customers experiencing temporary financial difficulties. See Note 3: Loan
Receivables to our condensed consolidated financial statements for additional
description of our use of loan modification programs to provide relief to
customers experiencing financial hardship.
Modified and Restructured Loans
For information regarding modified and restructured loans, see "- Loan Quality -
Delinquencies", "- Loan Quality - Impact of the COVID-19 Pandemic on the Loan
Portfolio", "- COVID-19 Pandemic Response and Impact - Loan Receivables" and
Note 3: Loan Receivables to our condensed consolidated financial statements.
Other Income
The following table presents the components of other income (dollars in
millions):
For the Three Months Ended 2021 vs 2020 For the Six Months Ended 2021 vs. 2020
June 30, Increase (Decrease) June 30, Increase (Decrease)
2021 2020 $ % 2021 2020 $ %
Discount and interchange revenue,
net(1) $ 339 $ 237 $ 102 43 % $ 580 $ 453 $ 127 28 %
Protection products revenue 43 44 (1) (2) % 86 91 (5) (5) %
Loan fee income 105 85 20 24 % 212 204 8 4 %
Transaction processing revenue 58 49 9 18 % 109 93 16 17 %
Unrealized gains on equity
investments 729 - 729 100 % 729 - 729 100 %
Realized gains on equity
investments - 43 (43) (100) % - 79 (79) (100) %
Other income 6 14 (8) (57) % 29 42 (13) (31) %
Total other income $ 1,280 $ 472 $ 808 171 % $ 1,745 $ 962 $ 783 81 %
(1)Net of rewards, including Cashback Bonus rewards, of $598 million and $385
million for the three months ended June 30, 2021 and 2020, respectively, and
$1.1 billion and $863 million for the six months ended June 30, 2021 and 2020,
respectively.
Total other income increased for the three and six months ended June 30, 2021 ,
as compared to the same periods in 2020, primarily due to an increase in
unrealized gains on equity investments and an increase in discount and
interchange revenue. In June 2021 , a payment services entity in which we hold a
non-controlling equity position completed its initial public offering, at which
time we began carrying the investment at fair value. The fair value adjustment
resulted in the recognition of a $729 million unrealized gain. The increase in
discount and interchange revenue was partially offset by an increase in rewards
costs, both of which were the result of higher sales volume. The increase in
total other income was partially offset by a decrease in realized gain on equity
investments related to sales in the three and six months ended June 30, 2020 .
63
--------------------------------------------------------------------------------
Table of Contents
Other Expense
The following table represents the components of other expense (dollars in
millions):
For the Three Months Ended 2021 vs. 2020 For the Six Months Ended June 2021 vs. 2020
June 30, Increase (Decrease) 30, Increase (Decrease)
2021 2020 $ % 2021 2020 $ %
Employee compensation and benefits
46 10 % $ 1,004 $ 919 $ 85 9 %
Marketing and business development 175 129 46 36 % 329 360 (31) (9) %
Information processing and
communications 145 117 28 24 % 254 231 23 10 %
Professional fees 187 181 6 3 % 369 374 (5) (1) %
Premises and equipment 22 27 (5) (19) % 46 57 (11) (19) %
Other expense 195 171 24 14 % 301 295 6 2 %
Total other expense $ 1,222 $ 1,077 $ 145 13 % $ 2,303 $ 2,236 $ 67 3 %
Total other expense increased for the three months ended June 30, 2021 , as
compared to the same period in 2020, primarily due to increases in employee
compensation and benefits, marketing and business development, information
processing and communications and other expense. Employee compensation and
benefits increased as a result of higher bonus accruals and higher average
salaries, partially offset by lower headcount. Marketing and business
development increased due to accelerated growth investments primarily in card.
Information processing and communications increased due to software write-offs.
Other expense increased due to an incremental non-cash impairment charge of
Diners Club intangible assets.
Total other expense increased for the six months ended June 30, 2021 , as
compared to the same period in 2020, primarily due to an increase in employee
compensation and benefits, partially offset by a decrease in marketing and
business development. Employee compensation and benefits increased as a result
of higher bonus accruals and higher average salaries, partially offset by lower
headcount. Marketing costs decreased primarily due to expense reductions in
acquisition and brand advertising for card during the first quarter of 2021.
Income Tax Expense
The following table presents the calculation of the effective income tax rate
(dollars in millions):
For the Three Months Ended June For the Six Months Ended June
30, 30,
2021 2020 2021 2020
Income (loss) before income taxes $ 2,222 $ (461) $ 4,301 $ (539)
Income tax expense (benefit) $ 524 $ (93) $ 1,010 $ (110)
Effective income tax rate 23.6 % 20.2 % 23.5 % 20.4 %
Income tax expense increased $617 million and $1.1 billion for the three and six
months ended June 30, 2021 , respectively, as compared to the same periods in
2020. The effective tax rate increased 3.4% and 3.1% for the three and six
months ended June 30, 2021 , respectively, as compared to the same periods in
2020. The increase in income tax expense was primarily driven by an increase in
pretax income. The effective tax rate increased primarily due to tax credits
having a lower rate benefit on higher pretax income.
Liquidity and Capital Resources
Impact of the COVID-19 Pandemic on Liquidity and Capital
The United States' economy has made substantial progress recovering from a brief
but severe recession caused by responses to the COVID-19 pandemic. While the
economic recovery is not yet complete, economic growth has been strong during
the first half of 2021.
64
--------------------------------------------------------------------------------
Table of Contents
We maintain ample capital to remain well-capitalized while simultaneously
financing loan receivable growth as customers moderate loan payment rates and
spend more as the economy reopens from the COVID-19 pandemic. Our store of
liquid assets remains in excess of historical norms as of June 30, 2021 as
consumer loan payment rates and deposit balances remain well above their
pre-pandemic levels. While our need for wholesale funding has been curtailed, we
maintain good access to all of our diverse funding channels. Credit spreads have
tightened materially this year, nearing record-low levels as of June 30, 2021 .
We remain well-capitalized with capital ratios in excess of regulatory minimums
and took prudent actions to preserve and augment our capital when the
macroeconomic and operating environment turned uncertain last year. In light of
the ongoing recovery of macroeconomic conditions, we resumed our common stock
repurchase program during the first quarter of 2021. Additionally, we submitted
our annual capital plan covering the January 1, 2021 to March 31, 2023 forecast
horizon as part of the Federal Reserve's capital stress test process. DFS was
not subject to the Federal Reserve's supervisory stress test in 2021, but will
be in 2022.
Funding and Liquidity
We seek to maintain stable, diversified and cost-effective funding sources and a
strong liquidity profile to fund our business and repay or refinance our
maturing obligations under normal operating conditions and periods of economic
or financial stress. In managing our liquidity risk, we seek to maintain a
prudent liability maturity profile and ready access to an ample store of primary
and 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, as well as secured borrowing capacity through private term
asset-backed securitizations and Federal Home Loan Bank advances. In addition,
we have unused borrowing capacity with the Federal 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
savings accounts, IRA certificates of deposit and checking/debit accounts.
Brokered deposits include certificates of deposit and sweep accounts. In
December 2020 , the Federal Deposit Insurance Corporation ("FDIC") issued the
final rule on revisions to its regulations on brokered deposits. We are
evaluating those changes, and as a result, certain retail deposit products such
as affinity deposits may no longer be categorized as brokered for regulatory
reporting purposes in the future. At June 30, 2021 , we had $62.6 billion of
direct-to-consumer deposits and $11.9 billion of brokered 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 Card Master Trust I
("DCMT") and the Discover Card Execution Note Trust ("DCENT"). In connection
with our securitization transactions, credit card receivables are transferred to
DCMT. DCMT has issued a certificate representing the beneficial interest in its
credit card receivables to DCENT. We issue DCENT DiscoverSeries notes in public
and private transactions, which are collateralized by the beneficial interest
certificate held by DCENT. From time to time, we may add credit card receivables
to DCMT to create sufficient funding capacity for future securitizations while
managing seller's interest. We retain significant exposure to the performance of
the securitized credit card receivables through holdings of the seller's
interest and subordinated classes of DCENT DiscoverSeries notes. At June 30,
2021 , we had $9.0 billion of outstanding public asset-backed securities and $4.5
billion of outstanding subordinated asset-backed securities that had been issued
to our wholly-owned subsidiaries.
The securitization structures include certain features designed to protect
investors. The primary feature relates to the availability and adequacy of cash
flows in the securitized pool of receivables to meet contractual requirements,
the insufficiency of which triggers early repayment of the securities. We refer
to this as "economic early amortization," which is based on excess spread
levels. Excess spread is the amount by which income received with respect to the
securitized credit card receivables during a collection period including
interest collections, fees and interchange, exceeds the fees and expenses of
DCENT during such collection period, including interest expense, servicing fees
and charged-off receivables. In the event
65
--------------------------------------------------------------------------------
Table of Contents
of an economic early amortization, which would occur if the excess spread fell
below 0% on a three-month rolling average basis, we would be required to repay
all outstanding securitized borrowings using available collections received with
respect to the securitized credit card receivables. For the three months ended
June 30, 2021 , the DiscoverSeries three-month rolling average excess spread was
14.15%. The period of ultimate repayment would be determined by the amount and
timing of collections received.
Through our wholly-owned indirect subsidiary, Discover Funding LLC , we are
required to maintain an interest in a contractual minimum level of receivables
in DCMT in excess of the face value of outstanding investors' interests. This
minimum interest is referred to as the minimum seller's interest. The required
minimum seller's interest in the pool of trust receivables is approximately 7%
in excess of the total investors' interests, which includes interests held by
third parties as well as those interests held by us. If the level of receivables
in DCMT were to fall below the required minimum, we would be required to add
receivables from the unrestricted pool of receivables, which would increase the
amount of credit card receivables restricted for securitization investors. A
decline in the amount of the excess seller's interest could occur if balance
repayments and charge offs exceeded new lending on the securitized accounts or
as a result of changes in total outstanding investors' interests. Seller's
interest exhibits seasonality as higher receivable balance repayments tend to
occur in the first calendar year quarter. If we could not add enough receivables
to satisfy the minimum seller's interest requirement, an early amortization (or
repayment) of investors' interests would be triggered.
An early amortization event would impair our liquidity and may require us to
utilize our available non-securitization-related contingent liquidity or rely on
alternative funding sources, which may or may not be available at the time. We
have several strategies we can deploy to prevent an early amortization event.
For instance, we could add additional receivables to DCMT, which would reduce
our available borrowing capacity at the Federal Reserve discount window. As of
June 30, 2021 , there were $25.1 billion of credit card receivables in the trust
and no accounts were added to those restricted for securitization investors for
the three and six months ended June 30, 2021 . Alternatively, we could employ
structured discounting, which was used effectively in 2009 to bolster excess
spread and mitigate early amortization risk.
The following table summarizes expected contractual maturities of the investors'
interests in credit card securitizations, excluding those that have been issued
to our wholly-owned subsidiaries (dollars in millions):
One Year Four Years
Less Than Through Through After Five
At June 30, 2021 Total One Year Three Years Five Years Years
Scheduled maturities of long-term
borrowings - owed to credit card
securitization investors $ 9,029 $ 4,375 The "AAA (sf)" and "Aaa(sf)" ratings of the DCENT DiscoverSeries Class A Notes issued to date have been based, in part, on anFDIC rule, which created a safe harbor that provides that theFDIC , as conservator or receiver, will not use its power to disaffirm or repudiate contracts, seek to reclaim or recover assets transferred in connection with a securitization, or recharacterize assets transferred in connection with a securitization as assets of the insured depository institution, provided such transfer satisfies the conditions for sale accounting treatment under previous GAAP. Although the implementation of FASB Accounting Standards Codification Topic 860, Transfers and Servicing, no longer qualified certain transfers of assets for sale accounting treatment, theFDIC 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 originalFDIC safe harbor if evaluated under GAAP pertaining to transfers of financial assets in effect prior toDecember 2009 . However, other legislative and regulatory developments may impact our ability or desire to issue asset-backed securities in the future. Federal Home Loan Bank AdvancesDiscover Bank is a member bank of theFederal Home Loan Bank of Chicago , one of 11 Federal Home Loan Banks ("FHLBs") that, along with theOffice of Finance , compose theFederal Home Loan Bank System . The FHLBs are government-sponsored enterprises ofthe United States of America ("U.S. GSEs") chartered to improve the availability of funds to support home ownership. As such, senior debt obligations of the FHLBs feature the same credit ratings asUnited States Treasury securities and are considered high-quality liquid assets for bank regulatory purposes. Consequently, the FHLBs benefit from consistent capital market access during nearly all macroeconomic and financial market conditions and low funding costs, which they pass on to their member banks when they borrow advances. Thus, we consider FHLB advances a stable and reliable funding source forDiscover Bank for short-term contingent liquidity and long-term asset-liability management. 66 -------------------------------------------------------------------------------- Table of Contents As a member of the FHLB ofChicago ,Discover Bank has access to short- and long-term advance structures with maturities ranging from overnight to 30 years. AtJune 30, 2021 , we had$1.2 billion of borrowing capacity through the FHLB ofChicago based on the amount and type of assets pledged. As ofJune 30, 2021 , there were no borrowings outstanding with the FHLB ofChicago . Under certain stressed conditions, we could pledge our liquidity portfolio securities and borrow against them at a modest reduction to their value. Other Long-Term Borrowings-Private Student Loans AtJune 30, 2021 ,$116 million of principal was outstanding on securitized debt assumed as part of our acquisition ofThe Student Loan Corporation . Principal and interest payments on the underlying private 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 ofDiscover Financial Services (Parent Company) andDiscover Bank outstanding fixed-rate debt (dollars in millions): Principal Amount AtJune 30, 2021 Outstanding
$ 177
Discover Bank fixed-rate senior bank notes, maturing 2021-2030 $ 6,100
Discover Bank fixed-rate subordinated bank notes, maturing 2028 $ 500
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 corresponding ratings downgrade 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 as United States Treasury bills or notes, or mortgage bonds or debentures issued by government agencies orU.S. GSEs. AtJune 30, 2021 , there were no outstanding balances in the federal funds market or under repurchase agreements. Additionally, the FHLB ofChicago offers short-term advance structures that we may use for short-term liquidity needs. AtJune 30, 2021 , there were no outstanding short-term advances from the FHLB. Additional Funding Sources Private Asset-Backed Securitizations We have access to committed borrowing capacity through privately placed asset-backed securitizations. While we may utilize funding from these private securitizations from time to time for normal business operations, their committed nature also makes them a reliable contingency funding source. Therefore, we reserve some undrawn capacity, informed by our liquidity stress test results, for potential contingency funding needs. As a result of our increased secured borrowing capacity through the FHLB ofChicago , we elected to terminate arrangements with three private asset-backed securitization facilities with an aggregate committed capacity of$2.0 billion in the second quarter of 2021. AtJune 30, 2021 , we had a total committed capacity of$4.0 billion , none of which was drawn. We 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 tests and seasonal funding needs.Federal Reserve Discover Bank has access to theFederal Reserve Bank of Philadelphia's discount window. As ofJune 30, 2021 ,Discover Bank had$32.3 billion of available borrowing capacity through the discount window based on the amount and type of assets pledged, primarily consumer loans. As ofJune 30, 2021 , we have no borrowings outstanding under the discount window and reserve this capacity as a source of contingent liquidity. 67 -------------------------------------------------------------------------------- Table of Contents 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. 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 credit 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. When the COVID-19 pandemic emerged in 2020, rating agencies cited their expectation that the banking industry would experience heightened loan delinquencies and charge offs from deterioration in the labor market. During the second quarter of 2020, Moody's, Standard and Poor's and Fitch Ratings affirmed our credit ratings. Standard and Poor's and Fitch changed the outlook onDiscover Financial Services' andDiscover Bank's senior unsecured credit ratings from "stable" to "negative" while Moody's retained a "stable" outlook on the credit ratings of each. OnMarch 25, 2021 , Standard and Poor's upgraded the outlook onDiscover Financial Services' andDiscover Bank's senior unsecured debt from "negative" to "stable," recognizing better-than-expected operating performance in 2020 and our strong loss-absorbing capacity. For similar reasons, onMay 3, 2021 , Fitch Ratings also affirmed the credit ratings onDiscover Financial Services' andDiscover Bank's senior unsecured debt and revised its outlook on those ratings from "negative" to "stable." Moreover, onMay 27, 2021 , Moody's affirmed its credit ratings forDiscover Financial Services andDiscover Bank while upgrading its outlook on those ratings from "stable" to "positive." The table below reflects our current credit ratings and outlooks. Moody's Investors Fitch Service Standard & Poor's RatingsDiscover Financial Services Senior unsecured debt Baa3 BBB- BBB+ Outlook forDiscover Financial Services senior unsecured debt Positive Stable Stable Discover Bank Senior unsecured debt Baa2 BBB BBB+ Outlook for Discover Bank senior unsecured debt Positive Stable Stable Subordinated debt Baa3 BBB- BBBDiscover 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. 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. Each rating should be evaluated independently of any other rating. A credit rating outlook reflects an agency's opinion regarding the likely rating direction over the medium term, often a period of about a year, and indicates the agency's belief that the issuer's credit profile is consistent with its current rating level at that point in time. Liquidity We seek to ensure that we have adequate liquidity to sustain business operations, fund asset growth and satisfy debt obligations under stressed and normal operating conditions. In addition to the funding sources discussed in the previous section, we also maintain highly liquid, unencumbered assets in our liquidity portfolio that we expect to be able to convert to cash quickly and with little loss of value using either the repo market or outright sales. 68 -------------------------------------------------------------------------------- Table of Contents We maintain a liquidity risk and funding management policy, which outlines the overall framework and general principles we follow in managing liquidity risk across our business. The Board of Directors approves the policy and theAsset and Liability Management Committee (the "ALCO") is responsible for its implementation. Additionally, we maintain a liquidity management framework document that outlines the general strategies, objectives and principles we utilize to manage our liquidity position and the various liquidity risks inherent in our business model. We seek to balance the trade-offs between maintaining too much liquidity, which may be costly, with having too little liquidity, which could cause financial distress. The ALCO, chaired by our Treasurer with cross-functional membership, centrally manages liquidity risk. 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 emerging liquidity stress events and a reporting and escalation process designed to be consistent with regulatory guidance. The EWIs include both idiosyncratic and systemic measures and are monitored daily and reported to the ALCO regularly. A warning from one or more of these indicators triggers prompt review and decision-making by our senior management team and, in certain instances, may lead to the convening of a senior-level response team and activation of our contingency funding plan. In addition, we conduct liquidity stress tests regularly and ensure contingency funding is in place to address potential liquidity shortfalls. We evaluate a range of stress scenarios that are designed according to 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 securities, which we could sell, repo or borrow against, and private securitizations with unused borrowing capacity. In addition, we could borrow FHLB advances by pledging securities to theFederal Home Loan Bank of Chicago . Moreover, 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 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. AtJune 30, 2021 , our liquidity portfolio is comprised of highly liquid, unencumbered assets, including cash and cash equivalents and investment securities. Cash and cash equivalents were primarily deposits with theFederal Reserve and United States Treasury bills. Investment securities primarily included debt obligations of the United States Treasury and residential mortgage-backed securities ("RMBS") issued byUnited States government agencies orU.S. GSEs. 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 on the size of our balance sheet as well as operational requirements, market conditions and interest rate risk management policies. For instance, our liquidity portfolio grew during 2020 as our customer deposits increased and our loan balances declined, reflecting consumers' response to the COVID-19 pandemic. 69 -------------------------------------------------------------------------------- Table of Contents AtJune 30, 2021 , our liquidity portfolio and undrawn credit facilities were$60.7 billion , which was$2.6 billion lower than the balance atDecember 31, 2020 . Our liquidity portfolio and undrawn credit facilities shrunk in the second quarter of 2021 due to the termination of three arrangements with private asset-backed securitization facilities with an aggregate committed capacity of$2.0 billion and the maturity of several long-term borrowings. The decrease was partially offset by the new$1.2 billion borrowing capacity through the FHLB ofChicago . During the three and six months endedJune 30, 2021 , the average balance of our liquidity portfolio was$27.1 billion and$27.6 billion , respectively. Our liquidity portfolio and undrawn facilities consist of the following (dollars in millions): June 30, December 31, 2021 2020 Liquidity portfolio Cash and cash equivalents(1)$ 14,688 $ 12,675 Other short-term investments - 2,200 Investment securities(2) 8,513 9,536 Total liquidity portfolio 23,201 24,411 Private asset-backed securitizations(3) 4,000
6,000
Federal Home Loan Bank of Chicago 1,209
-
Primary liquidity sources 28,410
30,411
Federal Reserve discount window(3) 32,328
32,930
Total liquidity portfolio and undrawn credit facilities
63,341
(1)Cash in the process of settlement and restricted cash are excluded from cash and cash equivalents for liquidity purposes. (2)Excludes$88 million and$117 million of United States Treasury securities that have been pledged as swap collateral in lieu of cash as ofJune 30, 2021 andDecember 31, 2020 , respectively. (3)See "- Loan Quality - Additional Funding Sources" for additional information. Bank Holding Company Liquidity The primary uses of funds at the unconsolidated DFS level include debt service obligations (interest payments and return of principal) and capital service and management activities, including dividend payments on capital instruments and the periodic repurchase of shares of our common stock. Our primary sources of funds at the bank holding company level include the proceeds from the issuance of unsecured debt and capital securities, as well as dividends from our subsidiaries, notablyDiscover 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. In managing this metric, we structure our debt maturity schedule to manage prudently the amount of debt maturing within a short period. See Note 7: Long-Term Borrowings to our condensed consolidated financial statements for further information regarding our debt. Capital Our primary sources of capital are the earnings generated by our businesses and the proceeds from issuances of capital securities. We seek to manage capital to a level and composition sufficient to support our businesses' growth and risks 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 capital levels. Failure to meet minimum capital requirements can result in the initiation of certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could limit our business activities and have a direct material effect on our financial condition and operating results. We must meet specific capital requirements that involve quantitative measures of assets, liabilities and certain off-balance sheet items, as calculated under regulatory guidance and regulations. Current or future legislative or regulatory reforms, such as the adoption of the Current Expected Credit Loss ("CECL") accounting model, 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. 70 -------------------------------------------------------------------------------- Table of ContentsDFS andDiscover Bank are subject to regulatory capital rules issued by theFederal Reserve and theFDIC , respectively, under the Basel Committee'sDecember 2010 framework ("Basel III rules"). Under the Basel III rules,DFS andDiscover Bank are classified as "Standardized Approach" entities as they areUnited States banking organizations with consolidated total assets over$50 billion but not exceeding$250 billion and consolidated total on-balance sheet foreign exposures less than$10 billion . The Basel III rules requireDFS andDiscover Bank to maintain minimum risk-based capital and leverage ratios and define what constitutes capital for purposes of calculating those ratios. Thresholds within the Basel III rules were fully phased in as ofJanuary 1, 2019 , except for certain transition provisions that were frozen pursuant to regulations 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. Additionally, onMarch 27, 2020 , federal bank regulatory agencies announced an interim and now final rule that allows banks that have implemented the CECL accounting model to delay the estimated impact of CECL on regulatory capital for two years, followed by a three-year transition period. For purposes of calculating regulatory capital, we have elected to defer recognition of the estimated impact of CECL on regulatory capital for two years in accordance with the final rule; after that period of deferral, the estimated impact of CECL on regulatory capital will be phased in over three years, beginning in 2022. We estimate that electing this option raised our Common Equity Tier 1 ("CET1") capital ratios in 2020 and 2021. For additional information regarding the risk-based capital and leverage ratios, see Note 12: Capital Adequacy to our condensed consolidated financial statements. OnMarch 4, 2020 , theFederal Reserve announced the SCB final rule, which imposes limitations on DFS' capital distributions if we do not maintain our capital ratios above stated regulatory minimum ratios based on the results of supervisory stress tests. DFS participated in the CCAR supervisory stress test in 2020 and received an SCB of 3.5%, which primarily reflects the difference between DFS' actual CET1 ratio as of the fourth quarter of 2019 and the projected minimum CET1 ratio based on theFederal Reserve's models in its nine-quarter Severely Adverse stress scenario. The SCB became effectiveOctober 1, 2020 and it is subject to change starting in the fourth quarter of 2021. Under this rule, we are required to assess whether our planned capital actions are consistent with the effective capital distribution limitations that will apply on a pro-forma basis throughout the planning horizon. See "- Regulatory Environment and Developments - Banking - Capital Standards and Stress Testing" for additional information. The Basel III rules provide certain threshold-based deductions from and adjustments to CET1 to the extent that any one such category or all such categories in the aggregate exceed certain percentages of CET1. InJuly 2019 , federal banking regulators issued a final rule that, among other things, revised certain capital requirements for Standardized Approach banks by raising the 10% of CET1 deduction threshold for certain items to 25% and eliminating the 15% combined deduction threshold applying to these items. These changes became effective for all Standardized Approach banking institutions inApril 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 the transparency of capital requirements for banking organizations. We are required to make prescribed regulatory disclosures quarterly regarding our capital structure, capital adequacy, risk exposures and risk-weighted assets. We make the Pillar 3 disclosures publicly available on our website in a report called "Basel III Regulatory Capital Disclosures." AtJune 30, 2021 ,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. 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. DFS is required to submit an annual capital plan as part of theFederal Reserve's capital stress test process. OnApril 5, 2021 , we submitted our capital plan to theFederal Reserve , covering theJanuary 1, 2021 toMarch 31, 2023 forecast horizon. DFS was not subject to the supervisory stress test (CCAR) in 2021, but will be in 2022. We disclose tangible common equity, which represents common equity less goodwill and intangibles. Management believes that common stockholders' equity excluding goodwill and intangibles is meaningful to investors as a measure of our true net asset value. As ofJune 30, 2021 , tangible common equity is considered to be a non-GAAP financial measure as it is not formally defined by GAAP or codified in the federal banking regulations. Other financial services companies may also disclose this measure and definitions may vary. We advise users of this information to exercise caution in comparing this measure for different companies. 71
--------------------------------------------------------------------------------
Table of Contents The following table provides a reconciliation of total common stockholders' equity (a GAAP financial measure) to tangible common equity (dollars in millions):
June 30 ,December 31, 2021 2020
Total common stockholders' equity(1)
(255) (255)
Less: intangible assets, net (1) (95)
Tangible common equity $ 11,859 $ 9,478
(1)Total common stockholders' equity is calculated as total stockholders' equity
less preferred stock.
Our Board of Directors declared common stock dividends during 2021 and 2020 as
follows:
Declaration Date Record Date Payment Date Dividend per Share
2021
July 20, 2021 August 19, 2021 September 02, 2021 $ 0.50
April 20, 2021 May 20, 2021 June 03, 2021 $ 0.44
January 19, 2021 February 18, 2021 March 04, 2021 $ 0.44
2020
October 20, 2020 November 19, 2020 December 03, 2020 $ 0.44
July 21, 2020 August 20, 2020 September 03, 2020 $ 0.44
April 21, 2020 May 21, 2020 June 04, 2020 $ 0.44
January 21, 2020 February 20, 2020 March 05, 2020 $ 0.44
In light of the pandemic-induced economic downturn in 2020, the Federal Reserve
required all large banks participating in the CCAR supervisory stress test to
cap common stock dividends at the lower of the prior quarter's dividend or the
average of a firm's net income over the preceding four quarters. The Federal
Reserve lifted this restriction as of July 1, 2021 . As a result, our Board of
Directors declared a common stock dividend of $0.50 per share on July 20, 2021 ,
an increase of $0.06 per share from the previous rate of $0.44 per common share.
Our Board of Directors declared Series C preferred stock dividends during 2021
and 2020 as follows:
Dividend per
Declaration Date Record Date Payment Date Depositary Share
2021
July 20, 2021 October 15, 2021 November 01, 2021 $ 27.50
January 19, 2021 April 15, 2021 April 30, 2021 $ 27.50
2020
July 21, 2020 October 15, 2020 October 30, 2020 $ 27.50
January 21, 2020 April 15, 2020 April 30, 2020 $ 27.50
Our Board of Directors declared Series D preferred stock dividends during 2021
and 2020 as follows:
Dividend per
Declaration Date Record Date Payment Date Depositary Share
2021
July 20, 2021 September 08, 2021 September 23, 2021 $ 30.63
January 19, 2021(1) March 08, 2021 March 23, 2021 $ 46.11 (1)The dividend includes
72
--------------------------------------------------------------------------------
Table of Contents
In light of the improved macroeconomic conditions and our strong financial
results, our Board of Directors approved a new share repurchase program in July
2021 . The new program authorizes up to $2.4 billion of share repurchases until
March 31, 2022 . This share repurchase authorization replaces our prior $1.1
billion share repurchase program, which was scheduled to expire on December 31,
2021 . Our decision to repurchase additional shares of common stock will depend
on our financial results, prevailing and expected economic conditions, potential
regulatory limitations and other considerations. We use various methods to
repurchase shares under the program, including open market purchases, privately
negotiated transactions or other purchases, including block trades, accelerated
share repurchase transactions, or any combination of such methods. During the
three months ended June 30, 2021 , we repurchased approximately 5 million shares
for approximately $550 million . During the six months ended June 30, 2021 , we
repurchased 6 million shares for approximately $650 million .
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 impact of CECL.
The declaration and payment of future dividends and the amount thereof are
subject to the discretion of our Board of Directors. Holders of our shares of
common stock are subject to the prior dividend rights of holders of our
preferred stock or the depositary shares representing such preferred stock
outstanding. No dividend may be declared or paid or set aside for payment on our
common stock if full dividends have not been declared and paid on all
outstanding shares of preferred stock in any dividend period. In addition, as
noted above, banking laws and regulations and our banking regulators may limit
our ability to pay dividends and make share repurchases, including limitations
on the extent our banking subsidiary 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. As a result, there
can be no assurance that we will declare and pay any dividends or repurchase any
shares of our common stock in the future.
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 by PULSE and Diners Club .
See Note 13: Commitments, Contingencies and Guarantees to our condensed
consolidated financial statements for further discussion regarding our
guarantees.
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 at June 30, 2021 ,
including deposits, long-term borrowings, operating lease obligations, interest
payments on fixed-rate debt, purchase obligations and other liabilities, were
$97.3 billion . For a description of our contractual obligations, see our annual
report on Form 10-K for the year ended December 31, 2020 , under "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Contractual Obligations and Contingent Liabilities and Commitments."
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. At June 30, 2021 , our unused credit arrangements were
approximately $215.8 billion . We can terminate substantially all of these
arrangements at any time and therefore the arrangements do not necessarily
represent future cash requirements. The arrangements 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 condensed consolidated financial statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk refers to the risk that a change in the level of one or more market
prices, rates, indices, correlations or other market factors will result in
losses for an investment position or portfolio. We are exposed to market risk
primarily from changes in interest rates.
73
--------------------------------------------------------------------------------
Table of Contents
Interest Rate Risk
We borrow money from various depositors and institutions to provide loans to our
customers and invest in other assets and our business. These loans to customers
and other assets earn interest, which we use to pay interest on the money
borrowed. Our net interest income and, therefore, earnings will be reduced if
the interest rate earned on assets increases at a slower pace than the interest
rate paid on our borrowings. Changes in interest rates and our competitors'
responses to those changes may influence customer payment rates, loan balances
or deposit account activity. As a result, we may incur higher funding costs that
would decrease our earnings.
Our interest rate risk management policies are designed to measure and manage
the potential volatility of earnings that may arise from changes in interest
rates by having a portfolio that reflects our mix of variable- and fixed-rate
assets and liabilities. To the extent that the repricing characteristics of the
assets and liabilities in a particular portfolio are not sufficiently matched,
we may utilize interest rate derivative contracts, such as swap agreements, to
achieve our objectives. Interest rate swap agreements effectively convert the
underlying asset or liability from fixed- to floating-rate or from floating- to
fixed-rate. See Note 16: Derivatives and Hedging Activities to our condensed
consolidated financial statements for information on our derivatives activity.
We use an interest rate sensitivity simulation to assess our interest rate risk
exposure. For purposes of presenting the possible earnings effect of a
hypothetical, adverse change in interest rates over the 12 months from our
reporting date, we assume that all interest rate sensitive assets and
liabilities 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 on the hypothetical assumption that all
relevant types of interest rates would change instantaneously, simultaneously
and to the same degree.
Our interest-rate-sensitive assets include our variable-rate loan receivables
and certain assets in our liquidity portfolio. We have limitations on our
ability to mitigate interest rate risk by adjusting rates on existing balances.
Further, competitive actions may limit our ability to increase the rates that we
charge to customers for new loans. At June 30, 2021 , the majority of our credit
card and private student loans charge variable rates. Fixed-rate assets that
will mature or otherwise contractually reset to a market-based indexed rate or
other fixed-rate prior to the end of the 12-month measurement period are
considered to be rate sensitive. The latter category includes certain revolving
credit card loans that may be offered at below-market rates for an introductory
period, such as balance transfers and special promotional programs, after which
the loans will contractually reprice in accordance with our normal market-based
pricing structure. For assets with a fixed interest rate that contractually
will, or 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 credit losses. For purposes
of this analysis, expected credit losses are assumed to remain unchanged
relative to our baseline expectations over the analysis horizon.
Interest-rate-sensitive liabilities are assumed to be those for which the stated
interest rate is not contractually fixed for the next 12 months. Thus,
liabilities that vary with changes in a market-based index, such as the federal
funds rate or LIBOR, which will reset before the end of the next 12 months, or
liabilities that have fixed rates at the fiscal period end but will mature and
are assumed to be replaced with a market-based indexed rate prior to the end of
the 12 months, are also considered to be rate sensitive. For these fixed-rate
liabilities, earnings sensitivity is measured from the expected maturity date.
Net interest income sensitivity requires assumptions regarding market
conditions, consumer behavior and overall growth and composition of the balance
sheet. The degree by which our deposit rates change when benchmark interest
rates change, our deposit "beta," is one of the most significant of these
assumptions. Assumptions about deposit beta and other matters are inherently
uncertain and, as a result, actual earnings may differ from the simulated
earnings presented below. Our actual earnings depend on multiple factors
including, but not limited to, the direction and timing of changes in interest
rates, the movement of short-term interest rates relative to long-term rates,
balance sheet composition, competitor actions affecting pricing decisions in our
loans and deposits and strategic actions undertaken by management.
74
--------------------------------------------------------------------------------
Table of Contents
Our current short-term interest rate risk position is moderately
asset-sensitive. We believe this position is prudent given that benchmark
interest rates remain well below historical levels. 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 June 30, 2021 At December 31, 2020
Basis point change $ % $ %
+100 $ 147 1.48 % $ 153 1.55 %
-100 N/A N/A N/A N/A
We have not provided an estimate of any impact on net interest income of a
decrease in interest rates at June 30, 2021 and December 31, 2020 , as many of
our interest rate sensitive assets and liabilities are tied to interest rates
(i.e., Prime and LIBOR) that are already at or near their historical minimum
levels and, therefore, could not materially decrease further assuming U.S.
market interest rates remain above zero percent. Sustained negative interest
rates for an economy with the size and complexity of the United States would
likely lead to broad macroeconomic impacts that are difficult to foresee. While
there is a possibility that United States market interest rates could fall below
zero percent, this has never occurred in the United States .
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including
our Chief Executive Officer and Chief Financial Officer, we conducted an
evaluation of the effectiveness of our disclosure controls and procedures (as
defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934,
as amended (the "Exchange Act")), which are designed to ensure that information
required to be disclosed by us in the reports that we file or submit under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified by the SEC's rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed by us in the reports that we
file or submit under the Exchange Act is accumulated and communicated to our
management, including our Chief Executive Officer and Chief Financial Officer,
as appropriate to allow timely decisions regarding required disclosure. Based on
this evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that our disclosure controls and procedures were effective as of the
end of the period covered by this report.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting (as
such term is defined in Exchange Act Rule 13a-15(f) and 15d-15(f)) that occurred
during the period covered by this report that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
75
--------------------------------------------------------------------------------
Table of Contents
Glossary of Acronyms
•ALCO: Asset and Liability Management Committee
•AOCI: Accumulated Other Comprehensive Income (Loss)
•ARPA: American Rescue Plan Act of 2021
•ARRC: Alternative Reference Rate Committee
•ASC: Accounting Standards Codification
•ASU: Accounting Standards Update
•CARES Act: Coronavirus Aid, Relief, and Economic Security Act
•CCAR: Comprehensive Capital Analysis and Review
•CCPA: California Consumer Privacy Act
•CECL: Current Expected Credit Loss
•CET1: Common Equity Tier 1
•CFPB: Consumer Financial Protection Bureau
•COVID-19: Coronavirus Disease 2019
•CPRA: California Privacy Rights Act
•DCENT: Discover Card Execution Note Trust
•DCMT: Discover Card Master Trust
•DFS: Discover Financial Services
•EPS: Earnings Per Share
•EWI: Early Warning Indicator
•FASB: Financial Accounting Standards Board
•FCA: UK Financial Conduct Authority
•FDIC: Federal Deposit Insurance Corporation
•FHLB: Federal Home Loan Bank
•GAAP: Accounting Principles Generally Accepted in the United States
•IRS: Internal Revenue Service
•LIBOR: London Interbank Offered Rate
•OCI: Other Comprehensive Income (Loss)
•OIS: Overnight Index Swap
•RMBS: Residential Mortgage-Backed Securities
•SaP: Skip-a-Pay (payment deferral) programs
•SCB: Stress Capital Buffer
•SEC: Securities and Exchange Commission
•SOFR: Secured Overnight Financing Rate
•TDR: Troubled Debt Restructuring
•USD: United States Dollar
•U.S. GSE: United States Government-Sponsored Entities
•VIE: Variable Interest Entity
76--------------------------------------------------------------------------------
Table of Contents
© Edgar Online, source
