Notes to the Consolidated Financial Statements
1.Background and Basis of Presentation
Description of Business
Discover Financial Services (“DFS” or the “Company”) is a digital banking and payment services company. The Company is a bank holding company under the Bank Holding Company Act of 1956 as well as a financial holding company under the Gramm-Leach-Bliley Act and therefore is subject to oversight, regulation and examination by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The Company provides digital banking products and services and payment services through its subsidiaries. The Company offers its customers credit card loans, private student loans, personal loans, home loans and deposit products. The Company also operates the Discover Network, the PULSE network (“PULSE”) and Diners Club International (“Diners Club”), collectively known as the Discover Global Network. The Discover Network processes transactions for Discover-branded credit and debit cards and provides payment transaction processing and settlement services. PULSE operates an electronic funds transfer network, providing financial institutions issuing debit cards on the PULSE network with access to ATMs domestically and internationally, as well as merchant acceptance throughout the U.S. for debit card transactions. Diners Club is a global payments network of licensees, which are generally financial institutions, that issue Diners Club branded charge cards and/or provide card acceptance services.
The Company’s business activities are managed in two segments, Digital Banking and Payment Services, based on the products and services provided. For a detailed description of the operations of each segment, as well as the allocation conventions used in business segment reporting, see Note 22: Segment Disclosures.
Basis of Presentation
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the U.S. (“GAAP”). The preparation of financial statements in conformity with GAAP requires the Company to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and related disclosures. These estimates are based on information available as of the date of the consolidated financial statements. The Company believes that the estimates used in the preparation of the consolidated financial statements are reasonable. Actual results could differ from these estimates.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. The Company’s policy is to consolidate all entities in which it owns more than 50% of the outstanding voting stock unless it does not control the entity. However, the Company did not have a controlling voting interest in any entity other than its wholly-owned subsidiaries in the periods presented in the accompanying consolidated financial statements.
It is also the Company’s policy to consolidate any VIEs for which the Company is the primary beneficiary, as defined by GAAP. On this basis, the Company consolidates the Discover Card Master Trust I (“DCMT”) and the Discover Card Execution Note Trust (“DCENT”) as well as the student loan securitization trust. The Company is deemed to be the primary beneficiary of each of these trusts since it is, for each, the trust Servicer and the holder of both the residual interest and the majority of the most subordinated interests. Because of those involvements, the Company has, for each trust, (i) the power to direct the activities that most significantly impact the economic performance of the trust and (ii) the obligation (or right) to absorb losses (or receive benefits) of the trust that could potentially be significant. The Company has determined that it was not the primary beneficiary of any other VIE during the years ended December 31, 2021, 2020 and 2019.
For investments in any entities in which the Company owns 50% or less of the outstanding voting stock but in which the Company has significant influence over operating and financial decisions, the Company applies the equity method of accounting. The Company also applies the equity method to its investments in qualified affordable housing projects and similar tax credit partnerships. In cases where the Company’s equity investment is less than 20% and significant influence does not exist, such investments are carried at cost as they typically do not have readily determinable fair values, and are adjusted for any impairment in value. Investments in actively traded stock are carried at fair value with changes in fair value recorded as an adjustment to earnings.
2. Summary of Significant Accounting Policies
Cash and Cash Equivalents
Cash and cash equivalents is defined by the Company as cash on deposit with banks, including time deposits and other highly liquid investments with maturities of 90 days or less when purchased, excluding amounts restricted by certain contractual or other obligations. Cash and cash equivalents included $1.2 billion and $1.1 billion of cash and due from banks and $7.6 billion and $12.5 billion of interest-earning deposits at other banks at December 31, 2021 and 2020, respectively.
Restricted Cash
Restricted cash includes cash in accounts from which the Company’s ability to withdraw funds at any time is contractually limited. Restricted cash is generally designated for specific purposes arising out of certain contractual or other obligations.
Investment Securities
At December 31, 2021, investment securities consisted of debt obligations of the U.S. Treasury and government-sponsored enterprises of the U.S. (“U.S. GSEs”) and mortgage-backed securities issued by government agencies or U.S. GSEs. Investment securities that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity and are reported at amortized cost. All other investment securities are classified as available-for-sale, as the Company does not hold investment securities for trading purposes. Available-for-sale investment securities are reported at fair value with unrealized gains and losses, net of tax, reported as a component of accumulated other comprehensive income (“AOCI”) included in stockholders’ equity. The Company estimates the fair value of available-for-sale investment securities as more fully discussed in Note 20: Fair Value Measurements. The amortized cost for each held-to-maturity and available-for-sale investment security is adjusted for amortization of premiums or accretion of discounts, as appropriate. Such amortization or accretion is included in interest income. Interest on investment securities is accrued each month in accordance with their contractual terms and recorded in other assets in the consolidated statements of financial condition. The U.S. Treasury and U.S. GSE obligations and mortgage-backed securities issued by government agencies or U.S. GSEs in which the Company invests have long histories with no credit losses and are explicitly or implicitly guaranteed by the U.S. government. Therefore, management has concluded that there is no expectation of non-payment on its investment securities and does not record an allowance for credit losses on these investments.
Loan Receivables
Loan receivables consist of credit card receivables and other loan receivables. The carrying values of all classes of loan receivables include unamortized net deferred loan origination fees and costs (also see “— Significant Revenue Recognition Accounting Policies — Loan Interest and Fee Income”). The credit card loan receivables carrying amount includes the principal amounts outstanding and uncollected billed interest and fees and is reduced for unearned revenue related to balance transfer fees (also see “— Significant Revenue Recognition Accounting Policies — Loan Interest and Fee Income”). Other loans consist of private student loans, personal loans and other loans and the carrying amount of those loans includes principal amounts outstanding. For private student loans, principal amounts outstanding also include accrued interest that has been capitalized. The Company’s loan receivables are deemed to be held-for-investment at origination or acquisition because management has the intent and ability to hold them for the foreseeable future. Cash flows associated with loans originated or acquired for investment are classified as cash flows from investing activities, regardless of a subsequent change in intent.
Delinquent Loans and Net Charge-Offs
The entire balance of an account is contractually past due if the minimum payment is not received by the specified date on the customer’s billing statement. Delinquency is reported on loans that are 30 days or more past due.
Credit card loans are charged off at the end of the month during which an account becomes 180 days past due. Closed-end unsecured consumer loan receivables are charged off at the end of the month during which an account becomes 120 days contractually past due. Customer bankruptcies and probate accounts are charged off by the end of the month 60 days following the receipt of notification of the bankruptcy or death, but not later than the 180-day or 120-day time frame described above. Receivables associated with alleged or potential fraudulent transactions are adjusted to their net realizable value upon receipt of notification of such fraud through a charge to other expense and are subsequently written off at the end of the month 90 days following notification, but not later than the contractual
180-day or 120-day time frame described above. The Company’s charge-off policies are designed to comply with guidelines established by the Federal Financial Institutions Examination Council (“FFIEC”).
The Company’s net charge-offs include the principal amount of loans charged off less principal recoveries and exclude charged-off interest and fees, recoveries of interest and fees and fraud losses.
The practice of re-aging an account also may affect loan delinquencies and charge-offs. A re-age is intended to assist delinquent customers who have experienced financial difficulties but who demonstrate both an ability and willingness to repay. Accounts meeting specific criteria are re-aged when the Company and the customer agree on a temporary repayment schedule that may include concessionary terms. With re-aging, the outstanding balance of a delinquent account is returned to a current status. Customers may also qualify for a workout re-age when either a longer term or permanent hardship exists. The Company’s re-age practices are designed to comply with FFIEC guidelines.
Allowance for Credit Losses
The Company maintains an allowance for credit losses at a level that is appropriate to absorb net credit losses anticipated over the remaining expected life of loan receivables as of the balance sheet date. The estimate of expected credit losses considers uncollectible principal, interest and fees associated with the Company's loan receivables existing as of the balance sheet date. Additionally, the estimate includes expected recoveries of amounts that were either previously charged off or are expected to be charged off. The allowance is evaluated quarterly for appropriateness and is maintained through an adjustment to the provision for credit losses. Charge-offs of principal amounts of loans outstanding are deducted from the allowance and subsequent recoveries of such amounts increase the allowance. Charge-offs of loan balances representing unpaid interest and fees result in a reversal of interest and fee income, respectively, which is effectively a reclassification of the provision for credit losses.
The Company calculates its allowance for credit losses by estimating expected credit losses separately for classes of receivables with similar risk characteristics. This results in segmenting the portfolio by loan product type, which is the level that the Company develops and documents its methodology for determining the allowance for credit losses. The estimate of expected credit losses for each loan product type is based on: (i) a reasonable and supportable forecast period; (ii) a reversion period; and (iii) a post-reversion period based on historical information covering the remaining life of the loan, all of which is netted with expected recoveries. The lengths of the reasonable and supportable forecast and reversion periods can vary and are subject to a quarterly assessment that considers the economic outlook and level of variability among macroeconomic forecasts. In benign economic conditions, the Company expects to apply a straight-line method to revert from the reasonable and supportable forecast period to the post-reversion period, but in certain stressed scenarios, a weighted approach may be deemed more appropriate.
Several analyses are used to help estimate credit losses anticipated over the remaining expected life of loan receivables as of the balance sheet date. The Company's estimation process includes models that predict customer losses based on risk characteristics and portfolio attributes, macroeconomic variables and historical data and analysis. There is a significant amount of judgment applied in selecting inputs and analyzing the results produced by the models to determine the allowance.
For credit card loans, the Company uses a modeling framework that includes the following components for estimating expected credit losses:
•Probability of default: this component estimates the probability of charge-off at different points in time over the life of each loan.
•Exposure at default: this component estimates the portion of the balance sheet date balance remaining at any given time of charge-off for each loan. Given that there is no stated life of a receivable balance on a revolving credit card account, the Company applies a percentage of expected payments to estimate the portion of the balance that would remain at the time of charge-off.
•Loss given default: this component estimates the percentage of exposure (i.e., net loss) at time of charge-off that cannot be recovered, with the offsetting forecast recoveries being the driver of this estimate.
•Recoveries from previously charged-off accounts are estimated separately and are netted as part of the aggregation of all of the components of the card loss modeling framework.
For private student loans and personal loans, the Company uses vintage-based models that estimate expected credit losses over the life of the loan, net of recovery estimates, impacted mainly by time elapsed since origination, credit quality of origination vintages and macroeconomic forecasts.
The components described above for credit card, private student and personal loans are developed utilizing historical data and applicable macroeconomic variable inputs based on statistical analysis and customer behavioral relationships with credit performance. Expected recoveries from loans charged off as of the balance sheet date are modeled separately and included in the allowance estimate. The Company leverages these models and recent macroeconomic forecasts for the portion of the estimate associated with the reasonable and supportable forecast period. To estimate expected credit losses for the remainder of the life of the credit card loans, the Company reverts to historical experience of credit card loans with characteristics similar to those as of the balance sheet date and observed over various phases of a credit cycle. To estimate expected credit losses for the remainder of the life of private student and personal loans, the Company generally reverts to use of average macroeconomic variables over an appropriate historical period.
The considerations in these models include past and current loan performance, loan growth and seasoning, risk management practices, account collection strategies, economic conditions, bankruptcy filings, policy changes and forecasting uncertainties. Consideration of past and current loan performance includes the post-modification performance of loans modified in a troubled debt restructuring. For the credit card loan portfolio, the Company estimates its credit losses on a loan-level basis, which includes loans that are delinquent and/or no longer accruing interest and/or loans that have been restructured. For the remainder of its portfolio, including private student, personal and other loans, the Company estimates its credit losses on a pooled basis. For all loan types, recoveries are estimated at a pooled level based on estimates of future cash flows derived using historical experience.
Accrued interest receivable on credit card loans is included in the estimate of expected credit losses once billed to the customer (i.e., once the interest becomes part of the loan balance). Except as noted in the following sentence, an allowance for credit losses is not recorded for unbilled credit card interest or accrued interest receivable on other loan classes as the impact to the allowance for credit losses is not material. Accrued interest receivable on student loans that have not yet entered repayment is included in the estimate of expected credit losses.
No liability for expected credit losses is required for unused lines of credit on the Company’s credit card loans because they are unconditionally cancellable. The Company records a liability for expected credit losses for unfunded commitments on all other loans, which is presented as part of accrued expenses and other liabilities in the consolidated statements of financial condition. This liability is evaluated quarterly for appropriateness and is maintained through an adjustment to the provision for credit losses.
As part of certain collection strategies, the Company may modify the terms of loans to customers experiencing financial hardship. Temporary and permanent modifications on credit card and personal loans, as well as temporary modifications on private student loans and certain grants of private student loan forbearance are generally accounted for as troubled debt restructurings. The Company classifies a modified loan in which a concession has been granted to the borrower as a troubled debt restructuring based on the cumulative length of the concession period and credit quality of the borrower.
Loan receivables that have been modified are subject to the same requirements for the accrual of expected credit loss over their expected remaining lives as described above for unmodified loans. The effects of all loan modifications, including troubled debt restructurings (“TDRs”), loan modifications exempt from TDR status pursuant to the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act”) and Skip-a-Pay (payment deferral) (“SaP”) programs, are reflected in the allowance for credit losses. An adjustment to the allowance for credit losses is not recorded for reasonably expected TDRs as the impact is not material. When the impact of the concession can only be captured by use of a discounted cash flow method (or a reconcilable method), such method is used to measure the allowance for credit losses.
Prior to the adoption of ASU No. 2016-13 on January 1, 2020, credit losses were estimated using the incurred loss approach. As required by the ASU, financial statement results and balances prior to January 1, 2020, have not been retrospectively adjusted to reflect the amendments in ASU No. 2016-13. Therefore, the balances and results as of and for the years ended December 31, 2021 and 2020 are not comparable to the balances and results as of and for the year ended December 31, 2019, particularly with regard to the provision and allowance for credit losses (and their related subtotals). See Note 2: Summary of Significant Accounting Policies to the consolidated financial statements of
the Company's annual report on Form 10-K for the year ended December 31, 2019 for more information related to the incurred loss approach.
Premises and Equipment, net
Premises and equipment, net, are stated at cost less provisions for impairment and accumulated depreciation and amortization. Accumulated depreciation and amortization is computed using the straight-line method over the estimated useful lives of the assets. The Company periodically reviews the estimated useful lives and may adjust them as necessary. Buildings are depreciated over a period of thirty-nine years. The costs of improvements are capitalized and depreciated either over the asset’s estimated useful life, typically ten years to fifteen years, or over the remaining term of the lease, when applicable. Furniture and fixtures are depreciated over a period of five years to ten years. Equipment is depreciated over three years to ten years. Maintenance and repairs are immediately expensed when incurred, while the costs of significant improvements are capitalized.
Purchased software and capitalized costs related to internally developed software are amortized over their useful lives of three years to ten years. Costs incurred during the application development stage related to internally developed software are capitalized. Costs are expensed as incurred during the preliminary project stage and post implementation stage. Once the capitalization criteria as defined in GAAP have been met, external direct costs incurred for materials and services used in developing or obtaining internal-use computer software and payroll and payroll-related costs for employees who are directly associated with the internal-use computer software project (to the extent those employees devoted time directly to the project) are capitalized. Amortization of capitalized costs begins when the software is ready for its intended use. Capitalized software is included in premises and equipment, net in the Company’s consolidated statements of financial condition. See Note 6: Premises and Equipment for further information about the Company’s premises and equipment.
Cloud computing arrangements involving the licensing of software that meet certain criteria are recognized as the acquisition of software. Such assets are measured at the present value of the license obligation, if the license is to be paid over time, in addition to any capitalized upfront costs and amortized over the life of the arrangement. Cloud computing arrangements that do not meet the criteria to be recognized as acquired software are accounted for as service contracts. To date, none of the Company’s cloud computing arrangements have met the criteria to be recognized as acquired software.
Premises and equipment are subject to impairment testing when events or conditions indicate that the carrying value of the asset may not be fully recoverable from future cash flows. See “— Intangible Assets” for additional details on impairment testing.
Goodwill
Goodwill is recorded as part of the Company’s acquisitions of businesses when the purchase price exceeds the fair value of the net tangible and separately identifiable intangible assets acquired. The Company’s goodwill is not amortized, but rather is subject to an impairment test at the reporting unit level annually as of October 1, or between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The Company’s reported goodwill relates to PULSE, which it acquired in 2005. The Company’s goodwill is tested for impairment by comparing the fair value of the reporting unit to its carrying value. If the fair value of the reporting unit exceeds its carrying value, goodwill is not impaired. If the carrying value exceeds its fair value, an impairment loss must be recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit. No impairment was identified during the impairment test conducted as of October 1, 2021.
Intangible Assets
The Company’s identifiable intangible assets consist of both amortizable and non-amortizable intangible assets. As of December 31, 2021, the Company’s identifiable intangible assets have no remaining net carrying value. The Company’s amortizable intangible assets consist primarily of acquired customer relationships and certain trade name intangibles, which were fully amortized as of December 31, 2021. The Company’s policy is to present amortizable intangible assets at net carrying value and to amortize them over their estimated useful lives. The amortization periods approximate the periods over which the Company expects to generate future net cash inflows from the use of these assets. The Company’s policy is to amortize intangibles in a manner that reflects the pattern in which the projected net cash inflows to the Company are expected to occur, where such pattern can be reasonably determined, as opposed to
the straight-line basis. This method of amortization typically results in a greater portion of the intangible asset being amortized in the earlier years of its useful life.
All of the Company’s amortizable intangible assets, as well as other amortizable or depreciable long-lived assets such as premises and equipment, are subject to impairment testing when events or conditions indicate that the carrying value of the asset may not be fully recoverable from future cash flows. A test for recoverability is done by comparing the asset’s carrying value to the sum of the undiscounted future net cash inflows expected to be generated from the use of the asset over its remaining useful life. Impairment exists if the sum of the undiscounted expected future net cash inflows is less than the carrying amount of the asset. Impairment would result in a write-down of the asset to its estimated fair value. The estimated fair values of these assets are based on the discounted present value of the stream of future net cash inflows expected to be derived over the remaining useful lives of the assets. If an impairment write-down is recorded, the remaining useful life of the asset will be evaluated to determine whether revision of the remaining amortization or depreciation period is appropriate.
The Company’s non-amortizable intangible assets consist primarily of the brand-related intangibles and international transaction processing rights included in the acquisition of Diners Club. As of December 31, 2021, these assets have been fully impaired. See Note 7: Goodwill and Intangibles for additional details on the Company’s intangible assets.
Stock-based Compensation
The Company measures the cost of employee services received in exchange for an award of stock-based compensation based on the grant-date fair value of the award. The cost, net of estimated forfeitures, is recognized over the requisite service period. Awards to employees who are retirement-eligible at any point during the year are amortized over 12 months in accordance with the vesting terms that apply under those circumstances. No compensation cost is recognized for awards that are subsequently forfeited.
Advertising Costs
The Company expenses television and radio advertising costs in the period in which the advertising is first aired and all other advertising costs as incurred. Advertising costs are recorded in marketing and business development and were $262 million, $212 million and $264 million for the years ended December 31, 2021, 2020 and 2019, respectively.
Income Taxes
Income tax expense is provided for using the asset and liability method, under which deferred tax assets and liabilities are determined based on the temporary differences between the financial reporting and income tax bases of assets and liabilities using currently enacted tax rates. Deferred tax assets are recognized when their realization is determined to be more likely than not. A valuation allowance is provided if the Company believes it is more likely than not that all or some portion of the deferred tax asset will not be realized. An increase or decrease in the valuation allowance that results from a change in circumstances and which causes a change in management’s judgment about the realizability of the related deferred tax asset is included in the current tax provision. Uncertain tax positions are measured at the highest amount of tax benefit for which realization is judged to be more likely than not. Tax benefits that do not meet these criteria are unrecognized tax benefits. The Company recognizes and reports interest and penalties, if necessary, related to uncertain tax positions within its provision for income tax expense. See Note 15: Income Taxes for more information about the Company’s income taxes.
Accumulated Other Comprehensive Income
The Company records unrealized gains and losses on available-for-sale securities, changes in the fair value of cash flow hedges and certain pension and foreign currency translation adjustments in other comprehensive income (“OCI”) on an after-tax basis where applicable. The Company’s policy is to adjust the tax effects of a component of AOCI in the same period in which the item is sold or otherwise derecognized, or when the carrying value of the item is remeasured. Details of OCI, net of tax, are presented in the statement of comprehensive income and a rollforward of AOCI is presented in the consolidated statements of changes in stockholders’ equity and Note 13: Accumulated Other Comprehensive Income.
Significant Revenue Recognition Accounting Policies
Loan Interest and Fee Income
Interest on loans is composed largely of interest on credit card loans and is recognized based on the amount of loans outstanding and their contractual interest rate. Interest on credit card loans is included in loan receivables when billed to the customer. The Company accrues unbilled interest revenue each month from a customer’s billing cycle date to the end of the month. The Company applies an estimate of the percentage of loans that will revolve in the next cycle in the estimation of the accrued unbilled portion of interest revenue that is included in other assets on the consolidated statements of financial condition. Interest on other loan receivables is accrued each month in accordance with their contractual terms and recorded in other assets in the consolidated statements of financial condition.
The Company recognizes fees (except balance transfer fees and certain product fees) on loan receivables in interest income or loan fee income as the fees are assessed. Balance transfer fees and certain product fees are recognized in interest income or loan fee income ratably over the periods to which they relate. Balance transfer fees are accreted to interest income over the estimated life of the related balance. As of December 31, 2021 and 2020, deferred revenues related to balance transfer fees, recorded as a reduction of loan receivables, were $62 million. Loan fee income consists of fees on credit card loans and includes late, cash advance, returned check and other miscellaneous fees and is reflected net of waivers and charge-offs.
Direct loan origination costs on credit card loans are deferred and amortized on a straight-line basis over a one year period and recorded in interest income from credit card loans. Direct loan origination costs on other loan receivables are deferred and amortized over the life of the loan using the interest method and are recorded in interest income from other loans. As of December 31, 2021 and 2020, the remaining unamortized deferred costs related to loan origination were $222 million and $157 million, respectively, and were recorded in loan receivables.
The Company accrues interest and fees on credit card and closed-end loan receivables until the loans are paid or charged off, except in instances of customer bankruptcy, death or suspected fraud, where no further interest and fee accruals occur following notification. Upon completion of the fraud investigation, non-fraudulent credit card and closed-end consumer loan receivables may resume accruing interest. Payments received on non-accrual loans are allocated according to the same payment hierarchy applied to loans that are accruing interest. When loan receivables are charged off, unpaid accrued interest and fees are reversed against the income line items in which they were originally recorded in the consolidated statements of income. Charge-offs and recoveries of amounts that relate to capitalized interest on private student loans are treated as principal charge-offs and recoveries, affecting the provision for credit losses rather than interest income. The Company considers uncollectible interest and fee revenues in assessing the adequacy of the allowance for credit losses.
Interest income from loans accounted for as troubled debt restructurings is accounted for in the same manner as other accruing loans. Cash collections on these loans are allocated according to the same payment hierarchy applied to loans that are not in such programs.
Discount and Interchange Revenue
The Company earns discount revenue from fees charged to merchants with whom it has entered into card acceptance agreements for processing credit card purchase transactions. The Company earns acquirer interchange revenue primarily from merchant acquirers on Discover Network, Diners Club and PULSE transactions made by credit and debit card customers at merchants with whom merchant acquirers have entered into card acceptance agreements for processing payment card transactions. These card acceptance arrangements generally renew automatically and do not have fixed durations. Under these agreements, the Company stands ready to process payment transactions as and when each is presented. The Company earns discount, interchange and similar fees only when transactions are processed. Contractually defined per-transaction fee amounts typically apply to each type of transaction processed and are recognized as revenue at the time each transaction is captured for settlement. These fees are typically collected by the Company as part of the process of settling transactions daily with merchants and acquirers and are fully earned at the time settlement is made.
The Company pays issuer interchange to card-issuing entities that have entered into contractual arrangements to issue cards on the Discover Network and on certain transactions on the Diners Club and PULSE networks. This cost is contractually established and is based on the card-issuing organization’s transaction volume. The Company classifies this cost as a reduction of discount and interchange revenue. Costs of cardholder reward arrangements, including the Cashback Bonus reward program, are classified as reductions of discount and interchange revenue pursuant to
guidance under Accounting Standards Codification (“ASC”) Topic 606 governing consideration payable to a customer. For both issuer interchange and transaction-based cardholder rewards, the Company accrues the cost at the time each underlying card transaction is captured for settlement.
Customer Rewards
The Company offers its customers various reward programs, including the Cashback Bonus reward program, pursuant to which the Company pays certain customers a reward equal to a percentage of their credit card purchase amounts based on the type and volume of the customer’s purchases. The liability for customer rewards is recorded on an individual customer basis and is accumulated as qualified customers earn rewards through their ongoing credit card purchase activity or other defined actions. The Company recognizes customer rewards costs as a reduction of the related revenue, if any. In instances where a reward is not associated with a revenue-generating transaction, such as when a reward is given for opening an account, the reward cost is recorded as an operating expense. For the years ended December 31, 2021, 2020 and 2019, rewards costs amounted to $2.5 billion, $1.9 billion and $1.9 billion, respectively. The liability for customer rewards was $2.0 billion and $1.7 billion at December 31, 2021 and 2020, respectively, and is included in accrued expenses and other liabilities on the consolidated statements of financial condition.
Protection Products Revenue
The Company earns revenue related to fees received for providing ancillary products and services, including payment protection and identity theft protection services, to its credit card customers. A portion of this revenue comprises amounts earned for arranging for the delivery of products offered by third-party service providers. The amount of revenue recorded is generally based on either a percentage of a customer’s outstanding balance or a flat fee, in either case assessed monthly and recognized as earned. These contracts are month-to-month arrangements that are cancellable at any time. The Company recognizes each monthly fee in the period to which the service or coverage relates.
Transaction Processing Revenue
Transaction processing revenue represents switch fees charged to financial institutions and merchants under network participation agreements for processing ATM and debit transactions over the PULSE network, as well as various participation and membership fees. Network participation agreements generally renew automatically and do not have fixed durations, although the Company does enter into fixed-term pricing or incentive arrangements with certain network participants. Similar to discount and interchange fees, switch fees are contractually defined per-transaction fee amounts and are assessed and recognized as revenue at the time each transaction is captured for settlement. These fees are typically collected by the Company as part of the process of settling transactions with network participants. Membership and other participation fees are recognized over the periods to which each fee relates.
Other Income
Other income includes unrealized gains and losses on equity investments carried at fair value, sales-based royalty revenues earned by Diners Club, merchant fees, revenues from network partners and other miscellaneous revenue items. Unrealized gains and losses on equity investments are recognized quarterly based on changes in their respective fair values. Sales-based royalty revenues are recognized as the related sales are reported by Diners franchisees. All remaining items of other income are recognized as the related performance obligations are satisfied.
Future Revenue Associated with Customer Contracts
For contracts under which the Company processes payment card transactions, the Company has the right to assess fees for services performed and to collect those fees through the settlement process. The Company generates essentially all of its discount and interchange revenue and transaction processing revenue, as well as some revenue reported as other income, through such contracts. There is no specified quantity of service promised in these contracts as the number of payment transactions is dependent upon cardholder behavior, which is outside the control of the Company and its network customers (i.e., merchants, acquirers, issuers and other network participants). As noted above, these contracts are typically without fixed durations and renew automatically. For these reasons, the Company does not make or disclose an estimate of revenue associated with performance obligations attributable to the remaining terms of these contracts. Future revenue associated with the Company’s sales-based royalty revenues earned from Diners Club licensees is similarly variable and open-ended and therefore the Company does not make or disclose an estimate of royalties associated with performance obligations attributable to the remaining terms of the licensing and
royalty arrangements. Because of the nature of the services and the manner of collection associated with the majority of the Company’s revenue from contracts with customers, material receivables or deferred revenues are not generated.
Incentive Payments
The Company makes certain incentive payments under contractual arrangements with financial institutions, Diners Club licensees, merchants, acquirers and certain other customers. These payments are generally classified as contra-revenue unless a distinct good or service is received by the Company in exchange for the payment and the fair value of the good or service can be reasonably estimated. If no such good or service is identified, then the entire payment is classified as contra-revenue and included in the consolidated statements of income in the line item where the related revenues are recorded. If the payment gives rise to an asset because it is expected to directly or indirectly contribute to future net cash inflows, it is deferred and recognized over the expected benefit period. The unamortized portion of the deferred incentive payments included in other assets on the consolidated statements of financial condition was $33 million at December 31, 2021 and 2020.
3. Investments
The Company’s other short-term investments and investment securities consist of the following (dollars in millions): | | | | | | | | | | | |
| December 31, |
| 2021 | | 2020 |
U.S. Treasury bills(1) | $ | — | | | $ | 2,200 | |
| | | |
Total other short-term investments | $ | — | | | $ | 2,200 | |
| | | |
U.S. Treasury securities(2) and U.S. GSE(3) securities | $ | 6,514 | | | $ | 9,354 | |
Residential mortgage-backed securities - Agency(3) | 390 | | | 560 | |
Total investment securities | $ | 6,904 | | | $ | 9,914 | |
| | | |
(1)Includes U.S. Treasury bills with maturity dates greater than 90 days but less than one year at the time of acquisition.
(2)Includes $27 million and $117 million of U.S. Treasury securities pledged as swap collateral as of December 31, 2021 and 2020, respectively.
(3)Consists of securities issued by Fannie Mae, Freddie Mac, Ginnie Mae, or the Federal Home Loan Bank.
The amortized cost, gross unrealized gains and losses and fair value of available-for-sale and held-to-maturity investment securities are as follows (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | |
| Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Fair Value |
December 31, 2021 | | | | | | | |
Available-for-Sale Investment Securities(1) | | | | | | | |
U.S. Treasury and U.S. GSE securities | $ | 6,368 | | | $ | 146 | | | $ | — | | | $ | 6,514 | |
Residential mortgage-backed securities - Agency | 181 | | | 5 | | | — | | | 186 | |
Total available-for-sale investment securities | $ | 6,549 | | | $ | 151 | | | $ | — | | | $ | 6,700 | |
Held-to-Maturity Investment Securities(2) | | | | | | | |
Residential mortgage-backed securities - Agency(3) | $ | 204 | | | $ | 3 | | | $ | (1) | | | $ | 206 | |
Total held-to-maturity investment securities | $ | 204 | | | $ | 3 | | | $ | (1) | | | $ | 206 | |
| | | | | | | |
December 31, 2020 | | | | | | | |
Available-for-Sale Investment Securities(1) | | | | | | | |
U.S. Treasury securities | $ | 8,987 | | | $ | 367 | | | $ | — | | | $ | 9,354 | |
Residential mortgage-backed securities - Agency | 290 | | | 10 | | | — | | | 300 | |
Total available-for-sale investment securities | $ | 9,277 | | | $ | 377 | | | $ | — | | | $ | 9,654 | |
Held-to-Maturity Investment Securities(2) | | | | | | | |
Residential mortgage-backed securities - Agency(3) | $ | 260 | | | $ | 9 | | | $ | — | | | $ | 269 | |
Total held-to-maturity investment securities | $ | 260 | | | $ | 9 | | | $ | — | | | $ | 269 | |
| | | | | | | |
(1)Available-for-sale investment securities are reported at fair value.
(2)Held-to-maturity investment securities are reported at amortized cost.
(3)Amounts represent residential mortgage-backed securities (“RMBS”) that were classified as held-to-maturity as they were entered into as a part of the Company’s community reinvestment initiatives.
The Company invests in U.S. Treasury obligations and securities issued by U.S. GSEs, which have long histories with no credit losses and are explicitly or implicitly guaranteed by the U.S. federal government. Therefore, management has concluded that there is no expectation of non-payment on its investment securities and does not record an allowance for credit losses on these investments.
At December 31, 2021, there were three investment securities with an aggregate fair value of $117 million that had an immaterial aggregate unrealized loss for less than 12 months and no securities in an unrealized loss position for more than 12 months. As of December 31, 2020, there were no investment securities with aggregate gross unrealized losses.
During the year ended December 31, 2021, the Company received $5 million of proceeds from the sale of available-for-sale securities. As a result of the sale, the Company recognized an immaterial gain during the year ended December 31, 2021. There were no proceeds from sales or recognized gains and losses on available-for-sale securities during the years ended December 31, 2020 and 2019. See Note 13: Accumulated Other Comprehensive Income for unrealized gains and losses on available-for-sale securities during the years ended December 31, 2021, 2020 and 2019.
Maturities and weighted-average yields of available-for-sale debt securities and held-to-maturity debt securities are provided in the following tables (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
At December 31, 2021 | One Year or Less | | After One Year Through Five Years | | After Five Years Through Ten Years | | After Ten Years | | Total |
Available-for-Sale Investment Securities — Amortized Cost | | | | | | | | | |
U.S. Treasury and U.S. GSE securities | $ | 1,995 | | | $ | 4,365 | | | $ | 8 | | | $ | — | | | $ | 6,368 | |
Residential mortgage-backed securities - Agency(1) | 2 | | | 15 | | | 157 | | | 7 | | | 181 | |
Total available-for-sale investment securities | $ | 1,997 | | | $ | 4,380 | | | $ | 165 | | | $ | 7 | | | $ | 6,549 | |
Held-to-Maturity Investment Securities — Amortized Cost | | | | | | | | | |
Residential mortgage-backed securities - Agency(1) | $ | — | | | $ | — | | | $ | — | | | $ | 204 | | | $ | 204 | |
Total held-to-maturity investment securities | $ | — | | | $ | — | | | $ | — | | | $ | 204 | | | $ | 204 | |
| | | | | | | | | |
Available-for-Sale Investment Securities — Fair Values | | | | | | | | | |
U.S. Treasury and U.S. GSE securities | $ | 2,014 | | | $ | 4,491 | | | $ | 9 | | | $ | — | | | $ | 6,514 | |
Residential mortgage-backed securities - Agency(1) | 2 | | | 16 | | | 161 | | | 7 | | | 186 | |
Total available-for-sale investment securities | $ | 2,016 | | | $ | 4,507 | | | $ | 170 | | | $ | 7 | | | $ | 6,700 | |
Held-to-Maturity Investment Securities — Fair Values | | | | | | | | | |
Residential mortgage-backed securities - Agency(1) | $ | — | | | $ | — | | | $ | — | | | $ | 206 | | | $ | 206 | |
Total held-to-maturity investment securities | $ | — | | | $ | — | | | $ | — | | | $ | 206 | | | $ | 206 | |
| | | | | | | | | |
Available-for-Sale Investment Securities — Weighted-Average Yields(2) | | | | | | | | | |
U.S. Treasury and U.S. GSE securities | 2.32 | % | | 2.22 | % | | 1.23 | % | | — | % | | 2.25 | % |
Residential mortgage-backed securities - Agency(1) | 1.14 | % | | 1.74 | % | | 2.08 | % | | 0.90 | % | | 1.99 | % |
Total available-for-sale investment securities | 2.31 | % | | 2.22 | % | | 2.03 | % | | 0.90 | % | | 2.24 | % |
Held-to-Maturity Investment Securities — Weighted-Average Yields | | | | | | | | | |
Residential mortgage-backed securities(1) | — | % | | — | % | | — | % | | 2.79 | % | | 2.79 | % |
Total held-to-maturity investment securities | — | % | | — | % | | — | % | | 2.79 | % | | 2.79 | % |
| | | | | | | | | |
(1)Maturities of RMBS are reflective of the contractual maturities of the investment.
(2)The weighted-average yield for available-for-sale investment securities is calculated based on the amortized cost.
Taxable interest on investment securities was $182 million, $252 million and $179 million for the years ended December 31, 2021, 2020 and 2019, respectively. There was no U.S. federal income tax-exempt interest on investment securities for the years ended December 31, 2021, 2020 and 2019.
Other Investments
As a part of the Company’s community reinvestment initiatives, the Company has made equity investments in certain limited partnerships and limited liability companies that finance the construction and rehabilitation of affordable rental housing and stimulate economic development in low- to moderate-income communities. These investments are accounted for using the equity method of accounting and are recorded within other assets. The related commitment for future investments is recorded in accrued expenses and other liabilities within the consolidated statements of financial condition. The portion of each investment’s operating results allocable to the Company reduces the carrying value of the investments and is recorded in other expense within the consolidated statements of income. The Company further reduces the carrying value of the investments by recognizing any amounts that are in excess of future net tax benefits in other expense. The Company earns a return primarily through tax credits allocated to the affordable housing projects and the community revitalization projects. The Company does not consolidate these investments as the Company does not have a controlling financial interest in the investee entities. As of December 31, 2021 and 2020, the Company had outstanding investments in these entities of $388 million and $353 million, respectively, and related contingent liabilities for unconditional and legally binding delayed equity contributions of $92 million and $93 million, respectively. Of the above outstanding equity investments, the Company had $350 million and $324 million of investments related to
affordable housing projects as of December 31, 2021 and 2020, respectively, which had $80 million and $79 million of related contingent liabilities for unconditional and legally binding delay equity contributions, respectively.
The Company holds non-controlling equity positions in several payments services entities. Most of these investments are not subject to equity method accounting because the Company does not have significant influence over the investee. The common or preferred equity securities that the Company holds typically do not have readily determinable fair values. As a result, the majority of these investments are carried at cost minus impairment, if any. As of December 31, 2021 and 2020, the carrying value of these investments, which are recorded within other assets on the Company’s consolidated statements of financial condition, was $36 million and $35 million, respectively.
The Company also holds non-controlling equity positions in payment service entities that have actively traded stock and therefore have readily determinable fair values. As a result, these investments are carried at fair value based on the quoted share prices. As of December 31, 2021, the carrying value of these investments, which are recorded within other assets on the Company's consolidated statements of financial condition, was $461 million. At December 31, 2020, the Company did not have any investments carried at fair value. During the year ended December 31, 2021, the Company recognized unrealized gains of approximately $423 million on the consolidated statements of income related to these investments. The Company recognized no unrealized losses or gains during the years ended December 31, 2020 and 2019.
4. Loan Receivables
The Company has two loan portfolio segments: credit card loans and other loans.
The Company’s classes of receivables within the two portfolio segments are depicted in the following table (dollars in millions): | | | | | | | | | | | |
| December 31, |
| 2021 | | 2020 |
Credit card loans(1)(2) | $ | 74,369 | | | $ | 71,472 | |
Other loans(3) | | | |
Private student loans(4) | 10,113 | | | 9,954 | |
Personal loans | 6,936 | | | 7,177 | |
Other loans | 2,266 | | | 1,846 | |
Total other loans | 19,315 | | | 18,977 | |
Total loan receivables | 93,684 | | | 90,449 | |
Allowance for credit losses | (6,822) | | | (8,226) | |
Net loan receivables | $ | 86,862 | | | $ | 82,223 | |
| | | |
(1)Amounts include carrying values of $13.3 billion and $16.7 billion underlying investors’ interest in trust debt at December 31, 2021 and 2020, respectively, and $11.9 billion and $10.6 billion in seller’s interest at December 31, 2021 and 2020, respectively. See Note 5: Credit Card and Private Student Loan Securitization Activities for additional information.
(2)Unbilled accrued interest receivable on credit card loans, which is presented as part of other assets in the Company’s consolidated statements of financial condition, was $423 million and $420 million at December 31, 2021 and 2020, respectively.
(3)Accrued interest receivable on private student, personal and other loans, which is presented as part of other assets in the Company’s consolidated statements of financial condition, was $443 million, $42 million and $6 million, respectively, at December 31, 2021 and $469 million, $49 million and $6 million, respectively, at December 31, 2020.
(4)Amounts include carrying values of $207 million and $250 million in loans pledged as collateral against the note issued from a private student loan securitization trust at December 31, 2021 and 2020, respectively. See Note 5: Credit Card and Private Student Loan Securitization Activities for additional information.
Credit Quality Indicators
As part of credit risk management activities, on an ongoing basis, the Company reviews information related to the performance of a customer's account with the Company and information from credit bureaus, such as FICO or other credit scores, relating to the customer's broader credit performance. The Company actively monitors key credit quality indicators, including FICO scores and delinquency status, for credit card, private student and personal loans. These indicators are important to understand the overall credit performance of the Company's customers and their ability to repay.
FICO scores are generally obtained at the origination of the account and are refreshed monthly or quarterly thereafter to assist in predicting customer behavior. Historically, the Company has noted that accounts with FICO scores below 660 have larger delinquencies and credit losses than those with higher credit scores.
The following table provides the distribution of the amortized cost basis (excluding accrued interest receivable presented in other assets) by the most recent FICO scores available for the Company's customers for credit card, private student and personal loan receivables (dollars in millions):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Credit Risk Profile by FICO Score |
| December 31, |
| 2021 | | 2020 |
| 660 and Above | | Less than 660 or No Score | | 660 and Above | | Less than 660 or No Score |
| $ | | % | | $ | | % | | $ | | % | | $ | | % |
Credit card loans(1) | $ | 62,262 | | | 84 | % | | $ | 12,107 | | | 16 | % | | $ | 58,950 | | | 82 | % | | $ | 12,522 | | | 18 | % |
Private student loans by origination year(2)(3) | | | | | | | | | | | | | | | |
2021 | $ | 1,251 | | | 94 | % | | $ | 73 | | | 6 | % | | | | | | | | |
2020 | 1,561 | | | 96 | % | | 59 | | | 4 | % | | $ | 1,173 | | | 95 | % | | $ | 60 | | | 5 | % |
2019 | 1,439 | | | 96 | % | | 61 | | | 4 | % | | 1,659 | | | 96 | % | | 61 | | | 4 | % |
2018 | 1,147 | | | 95 | % | | 59 | | | 5 | % | | 1,365 | | | 96 | % | | 61 | | | 4 | % |
2017 | 866 | | | 94 | % | | 52 | | | 6 | % | | 1,052 | | | 95 | % | | 57 | | | 5 | % |
Prior | 3,349 | | | 94 | % | | 196 | | | 6 | % | | 4,219 | | | 94 | % | | 247 | | | 6 | % |
Total private student loans | $ | 9,613 | | | 95 | % | | $ | 500 | | | 5 | % | | $ | 9,468 | | | 95 | % | | $ | 486 | | | 5 | % |
Personal loans by origination year | | | | | | | | | | | | | | | |
2021 | $ | 3,326 | | | 99 | % | | $ | 37 | | | 1 | % | | | | | | | | |
2020 | 1,622 | | | 98 | % | | 39 | | | 2 | % | | $ | 2,880 | | | 99 | % | | $ | 25 | | | 1 | % |
2019 | 1,052 | | | 94 | % | | 62 | | | 6 | % | | 2,183 | | | 96 | % | | 90 | | | 4 | % |
2018 | 435 | | | 91 | % | | 44 | | | 9 | % | | 1,018 | | | 92 | % | | 90 | | | 8 | % |
2017 | 213 | | | 88 | % | | 30 | | | 12 | % | | 558 | | | 89 | % | | 69 | | | 11 | % |
Prior | 63 | | | 83 | % | | 13 | | | 17 | % | | 227 | | | 86 | % | | 37 | | | 14 | % |
Total personal loans | $ | 6,711 | | | 97 | % | | $ | 225 | | | 3 | % | | $ | 6,866 | | | 96 | % | | $ | 311 | | | 4 | % |
| | | | | | | | | | | | | | | |
(1)Amounts include $813 million and $1.0 billion of revolving line-of-credit arrangements that were converted to term loans as a result of a TDR program as of December 31, 2021 and 2020, respectively.
(2)A majority of private student loan originations occur in the third quarter and disbursements can span multiple calendar years.
(3)FICO score represents the higher credit score of the cosigner or borrower.
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 amortized cost basis (excluding accrued interest receivable presented in other assets) of delinquent loans in the Company’s loan portfolio is shown below for credit card, private student and personal loan receivables (dollars in millions):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, |
| 2021 | | 2020 |
| 30-89 Days Delinquent | | 90 or More Days Delinquent | | Total Past Due | | 30-89 Days Delinquent | | 90 or More Days Delinquent | | Total Past Due |
Credit card loans | $ | 670 | | | $ | 562 | | | $ | 1,232 | | | $ | 739 | | | $ | 739 | | | $ | 1,478 | |
Private student loans by origination year(1) | | | | | | | | | | | |
2021 | $ | — | | | $ | — | | | $ | — | | | | | | | |
2020 | 4 | | | 1 | | | 5 | | | $ | — | | | $ | — | | | $ | — | |
2019 | 9 | | | 2 | | | 11 | | | 3 | | | 1 | | | 4 | |
2018 | 14 | | | 4 | | | 18 | | | 9 | | | 3 | | | 12 | |
2017 | 15 | | | 5 | | | 20 | | | 12 | | | 4 | | | 16 | |
Prior | 79 | | | 24 | | | 103 | | | 86 | | | 20 | | | 106 | |
Total private student loans | $ | 121 | | | $ | 36 | | | $ | 157 | | | $ | 110 | | | $ | 28 | | | $ | 138 | |
Personal loans by origination year | | | | | | | | | | | |
2021 | $ | 5 | | | $ | 1 | | | $ | 6 | | | | | | | |
2020 | 7 | | | 2 | | | 9 | | | $ | 5 | | | $ | 2 | | | $ | 7 | |
2019 | 11 | | | 4 | | | 15 | | | 18 | | | 9 | | | 27 | |
2018 | 6 | | | 3 | | | 9 | | | 15 | | | 7 | | | 22 | |
2017 | 4 | | | 2 | | | 6 | | | 10 | | | 5 | | | 15 | |
Prior | 2 | | | 1 | | | 3 | | | 5 | | | 2 | | | 7 | |
Total personal loans | $ | 35 | | | $ | 13 | | | $ | 48 | | | $ | 53 | | | $ | 25 | | | $ | 78 | |
| | | | | | | | | | | |
(1)Private student loans may include a deferment period, during which borrowers are not required to make payments while enrolled in school at least half time as determined by the school. During a deferment period, these loans do not advance into delinquency.
Allowance for Credit Losses
The following tables provide changes in the Company’s allowance for credit losses (dollars in millions):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| For the Year Ended December 31, 2021 |
| Credit Card Loans | | Private 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) | 229 | | | 67 | | | (75) | | | 6 | | | 227 | |
Deductions | | | | | | | | | |
Charge-offs | (2,255) | | | (89) | | | (190) | | | — | | | (2,534) | |
Recoveries | 808 | | | 25 | | | 70 | | | — | | | 903 | |
Net charge-offs | (1,447) | | | (64) | | | (120) | | | — | | | (1,631) | |
| | | | | | | | | |
Balance at December 31, 2021 | $ | 5,273 | | | $ | 843 | | | $ | 662 | | | $ | 44 | | | $ | 6,822 | |
| | | | | | | | | |
| For the Year Ended December 31, 2020 |
| Credit Card Loans | | Private 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(1) | 4,379 | | | 251 | | | 476 | | | 11 | | | 5,117 | |
Deductions | | | | | | | | | |
Charge-offs | (3,101) | | | (85) | | | (289) | | | (1) | | | (3,476) | |
Recoveries | 663 | | | 21 | | | 57 | | | — | | | 741 | |
Net charge-offs | (2,438) | | | (64) | | | (232) | | | (1) | | | (2,735) | |
| | | | | | | | | |
Balance at December 31, 2020 | $ | 6,491 | | | $ | 840 | | | $ | 857 | | | $ | 38 | | | $ | 8,226 | |
| | | | | | | | | |
| For the Year Ended December 31, 2019 |
| Credit Card Loans | | Private Student Loans | | Personal Loans | | Other Loans | | Total Loans |
Balance at December 31, 2018(2) | $ | 2,528 | | | $ | 169 | | | $ | 338 | | | $ | 6 | | | $ | 3,041 | |
Additions | | | | | | | | | |
Provision for credit losses(2) | 2,849 | | | 51 | | | 332 | | | (1) | | | 3,231 | |
Deductions | | | | | | | | | |
Charge-offs | (3,165) | | | (82) | | | (369) | | | (1) | | | (3,617) | |
Recoveries | 671 | | | 13 | | | 47 | | | — | | | 731 | |
Net charge-offs(4) | (2,494) | | | (69) | | | (322) | | | (1) | | | (2,886) | |
Other(5) | — | | | (3) | | | — | | | — | | | (3) | |
Balance at December 31, 2019(2) | $ | 2,883 | | | $ | 148 | | | $ | 348 | | | $ | 4 | | | $ | 3,383 | |
| | | | | | | | | |
(1)Excludes a $9 million and $17 million reclassification of the liability for expected credit losses on unfunded commitments for the years ended December 31, 2021 and 2020, respectively, as the liability is recorded in accrued expenses and other liabilities in the Company’s consolidated statements of financial condition.
(2)Prior to the adoption of ASU No. 2016-13 on January 1, 2020, credit losses were estimated using the incurred loss approach.
(3)Represents the adjustment to the allowance for credit losses as a result of the adoption of ASU No. 2016-13 on January 1, 2020.
(4)Prior to the adoption of ASU No. 2016-13 on January 1, 2020, net charge-offs on purchased credit-deteriorated (“PCD”) loans generally did not result in a charge to earnings.
(5)Net change in reserves on PCD pools having no remaining non-accretable difference (prior to adoption of ASU No. 2016-13 on January 1, 2020).
The allowance for credit losses was approximately $6.8 billion at December 31, 2021, which reflects a $1.4 billion release from the amount of the allowance for credit losses at December 31, 2020. The release in the allowance for credit losses between December 31, 2021 and December 31, 2020, was primarily driven by improvements in the macroeconomic forecast and continued stable credit performance, partially offset by modest credit card loan receivables growth during the period. The increase in credit card loan receivables was driven by the robust sales trends during the period as coronavirus disease 2019 (“COVID-19”) restrictions continue to ease and the U.S. economy continues to more fully reopen. The loan receivables growth during the period was partially offset by elevated payment rates resulting from government stimulus and disaster relief programs.
In estimating the allowance at December 31, 2021, the Company used a macroeconomic forecast that projected (i) a peak unemployment rate of 5.7%, decreasing to 4.0% by the end of 2022 with slow improvement over the next few years and (ii) 3.3% annualized growth in the real gross domestic product in 2022. Labor market conditions, which historically have been an important determinant of credit loss trends, continued to improve as of December 31, 2021, despite the spread of the Delta and Omicron variants of COVID-19. While initial jobless claims have returned to pre-pandemic levels, continuing unemployment claims and the unemployment rate remain moderately elevated relative to pre-pandemic levels as of December 31, 2021.
In estimating expected credit losses, the Company 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 the American Rescue Plan Act of 2021 (“ARPA”), and disaster relief programs, such as foreclosure moratoriums and federal student loan and mortgage payment forbearance. During the third and fourth quarters of 2021, several disaster relief programs expired or were rescinded entirely. As the government’s response to the pandemic wanes and the economy continues to experience aspects of stress resulting from the pandemic, there is uncertainty regarding the sustainability of the recent credit quality trends in the Company’s loan receivables portfolio. Accordingly, the estimation of the allowance for credit losses has required significant management judgment.
Company-initiated loan modification programs include those specifically offered in response to the COVID-19 pandemic as well as existing programs offered to customers experiencing difficulty making their payments. In addition to the SaP programs, which ended on August 31, 2020, the Company has other modification programs that customers have utilized during the period related to the pandemic. The Company evaluated the accounts using these modifications as a result of the COVID-19 pandemic 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 effects of all modifications, including TDRs, loan modifications exempt from the TDR designation pursuant the CARES Act and SaP programs, are considered as part of the process for determining the allowance for credit losses.
The forecast period the Company deemed to be reasonable and supportable was 18 months for all periods presented except March 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 stability of the economic outlook and relative consistency among the macroeconomic forecasts. For all periods presented, the Company determined that a reversion period of 12 months was appropriate for similar reasons. Due to the uncertainties associated with borrower behavior resulting from government stimulus and disaster relief programs, the Company 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: at March 31, 2020 and December 31, 2019, the Company applied a straight-line method for all loan products. At June 30, 2020, the Company applied a weighted reversion method for credit card loans and a straight-line method for all other loan products.
The net charge-offs and charge-off rate on the Company’s credit card loans for the year ended December 31, 2021, decreased when compared to the year ended December 31, 2020, primarily due to a decrease in the number of delinquent loans and lower average balances charged-off. These factors are a result of the impacts of government stimulus and disaster relief programs. The net charge-offs and net charge-off rate on private student loans for the year ended December 31, 2021, remained relatively flat when compared to the year ended December 31, 2020. The net charge-offs and net charge-off rate on personal loans for the year ended December 31, 2021, decreased when compared to the year ended December 31, 2020, due to the impacts of government stimulus and disaster relief programs and tighter underwriting standards that were implemented in early 2020.
Net charge-offs of principal are recorded against the allowance for credit losses, as shown in the preceding table. Information regarding net charge-offs of interest and fee revenues on credit card and other loans is as follows (dollars in millions): | | | | | | | | | | | | | | | | | |
| For the Years Ended December 31, |
| 2021 | | 2020 | | 2019 |
Interest and fees accrued subsequently charged off, net of recoveries (recorded as a reduction of interest income) | $ | 286 | | | $ | 484 | | | $ | 515 | |
Fees accrued subsequently charged off, net of recoveries (recorded as a reduction to other income) | $ | 75 | | | $ | 117 | | | $ | 123 | |
| | | | | |
Delinquent and Non-Accruing Loans
The amortized cost basis (excluding accrued interest receivable presented in other assets) of delinquent and non-accruing loans in the Company’s loan portfolio is shown below for each class of loan receivables (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| 30-89 Days Delinquent | | 90 or More Days Delinquent | | Total Past Due | | 90 or More Days Delinquent and Accruing | | Total Non-accruing(1) |
December 31, 2021 | | | | | | | | | |
Credit card loans | $ | 670 | | | $ | 562 | | | $ | 1,232 | | | $ | 527 | | | $ | 194 | |
Other loans | | | | | | | | | |
Private student loans | 121 | | | 36 | | | 157 | | | 35 | | | 8 | |
Personal loans | 35 | | | 13 | | | 48 | | | 12 | | | 7 | |
Other loans | 7 | | | 7 | | | 14 | | | 1 | | | 16 | |
Total other loans | 163 | | | 56 | | | 219 | | | 48 | | | 31 | |
Total loan receivables | $ | 833 | | | $ | 618 | | | $ | 1,451 | | | $ | 575 | | | $ | 225 | |
| | | | | | | | | |
December 31, 2020 | | | | | | | | | |
Credit card loans | $ | 739 | | | $ | 739 | | | $ | 1,478 | | | $ | 687 | | | $ | 209 | |
Other loans | | | | | | | | | |
Private student loans | 110 | | | 28 | | | 138 | | | 27 | | | 12 | |
Personal loans | 53 | | | 25 | | | 78 | | | 23 | | | 12 | |
Other loans | 8 | | | 3 | | | 11 | | | — | | | 10 | |
Total other loans | 171 | | | 56 | | | 227 | | | 50 | | | 34 | |
Total loan receivables | $ | 910 | | | $ | 795 | | | $ | 1,705 | | | $ | 737 | | | $ | 243 | |
| | | | | | | | | |
(1)The Company estimates that the gross interest income that would have been recorded under the original terms of non-accruing credit card loans was $28 million, $33 million and $45 million for the years ended December 31, 2021, 2020 and 2019, respectively. The Company does not separately track the amount of gross interest income that would have been recorded under the original terms of loans. Instead, the Company estimated this amount based on customers’ current balances and most recent interest rates.
The payment status of modified accounts, including those identified as TDRs and those exempt from the TDR designation pursuant to the CARES Act, is reflected in the Company’s delinquency reporting.
Troubled Debt Restructurings
The Company has internal loan modification programs that provide relief to credit card, private student and personal loan borrowers who may be experiencing financial hardship. The Company considers a modified loan in which a concession has been granted to the borrower to be a TDR based on the cumulative length of the concession period and credit quality of the borrower. The Company evaluates new programs to determine which of them meet the definition of a TDR, including modification programs provided to customers for temporary relief due to the economic impacts of the COVID-19 pandemic. The internal loan modification programs include both temporary and permanent programs, which vary by product. External loan modification programs are also available for credit card and personal
loans. All loans modified in a temporary modification program, including those specifically created in response to the COVID-19 pandemic, are evaluated for exclusion from the TDR designation either due to the insignificance of the concession or because they qualify for exemption pursuant to the CARES Act. To the extent the loan accounts do not meet the requirements for exclusion, temporary and permanent modifications on credit card and personal loans, as well as temporary modifications on private student loans and certain grants of private student loan forbearance, result in the loans being classified as TDRs. In addition, loans that defaulted from, or successfully completed a loan modification program or forbearance, continue to be classified as TDRs, except as noted in the following paragraph. See the table below that presents the carrying value of loans that entered a TDR program and experienced a default during the period for more information.
For credit card customers, the Company offers both temporary and permanent hardship programs. The temporary hardship programs consist of an interest rate reduction and in some cases a reduced minimum payment, both lasting for a period no longer than 12 months. Charging privileges on these accounts are generally suspended while in the program. However, if the customer meets certain criteria, charging privileges may be reinstated following completion of the program. Credit card accounts of borrowers who have previously participated in a temporary interest rate reduction program and that have both demonstrated financial stability and had their charging privileges reinstated at a market-based interest rate, are excluded from the balance of TDRs.
The permanent modification program involves closing the account, changing the structure of the loan to a fixed payment loan with a maturity no longer than 72 months and reducing the interest rate on the loan. The permanent modification program does not typically provide for the forgiveness of unpaid principal, but may allow for the reversal of certain unpaid interest or fee assessments. The Company also makes permanent loan modifications for customers who request financial assistance through external sources, such as a consumer credit counseling agency program. These loans typically receive a reduced interest rate, typically continue to be subject to the original minimum payment terms and do not normally include waiver of unpaid principal, interest or fees. These permanent loan modifications remain in the population of TDRs until they are paid off or charged off.
At December 31, 2021 and 2020, there were $5.8 billion and $5.7 billion, respectively, of private student loans in repayment and $64 million and $117 million, respectively, in forbearance. To assist private student loan borrowers who are experiencing temporary financial difficulties but are willing to resume making payments, the Company may offer hardship forbearance, payment deferral, a temporary payment reduction, a temporary interest rate reduction or extended terms. A modified loan typically meets the definition of a TDR based on the cumulative length of the concession period and a determination of financial distress based on an evaluation of the borrower’s credit quality using FICO scores.
For personal loan customers, the Company offers various payment programs, including temporary and permanent programs, in certain situations. The temporary programs normally consist of reducing the minimum payment for no longer than 12 months. Further, the interest rate on the loan is reduced in certain circumstances. The permanent programs involve extending the loan term and, in certain circumstances, reducing the interest rate on the loan. The total term of the loan, including modification, may not exceed nine years. The Company also allows permanent loan modifications for customers who request financial assistance through external sources, similar to the credit card customers discussed above. Payments are modified based on the new terms agreed upon with the credit counseling agency. Personal loans included in temporary and permanent programs are classified as TDRs.
The Company monitors borrower performance after using payment programs or forbearance. The Company believes the programs are useful in assisting customers experiencing financial difficulties and allowing them to make timely payments. In addition to helping customers with their credit needs, these programs are designed to maximize collections and ultimately the Company’s profitability. The Company plans to continue to use payment programs and forbearance to provide relief to customers experiencing temporary financial difficulties and expects to have additional loans classified as TDRs in the future as a result.
To evaluate the primary financial effects that resulted from credit card loans entering into a TDR program during the years ended December 31, 2021, 2020 and 2019, the Company quantified the amount by which interest and fees were reduced during the periods. During the years ended December 31, 2021, 2020 and 2019, the Company forgave approximately $33 million, $66 million and $73 million, respectively, of interest and fees resulting from accounts entering into a credit card loan TDR program. For all loan products, interest income on modified loans is recognized based on the modified contractual terms.
Section 4013 of the CARES Act provided 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 loan modification relief provided by the CARES Act through the earlier of January 1, 2022, or the date that is 60 days after the termination of the presidentially-declared national emergency. The Company elected to apply the option to suspend the application of accounting guidance for TDRs as provided under Section 4013 of the CARES Act and as subsequently extended. As such, TDR program balances and the number of accounts have been favorably impacted by the exclusion of certain modifications from the TDR designation pursuant to these exemptions and were lower than they otherwise would have been. Section 4013 of the CARES Act expired on January 1, 2022. Upon expiration, the characterization of modified accounts that were exempt from the TDR designation pursuant to Section 4013 of the CARES Act is not reconsidered. Accordingly, these accounts continue to be exempt from the TDR designation unless a subsequent modification is made. Loan modifications made subsequent to the expiration of Section 4013 are evaluated under U.S. GAAP to determine whether the TDR designation applies based on the cumulative length of the concession period and credit quality of the borrower.
The following table provides information on loans that entered a TDR program during the period (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| For the Years Ended December 31, |
| 2021 | | 2020 | | 2019 |
| Number of Accounts | | Balances | | Number of Accounts | | Balances | | Number of Accounts | | Balances |
Accounts that entered a TDR program during the period | | | | | | | | | | | |
Credit card loans(1) | 64,359 | | | $ | 399 | | | 152,055 | | | $ | 1,022 | | | 368,009 | | | $ | 2,364 | |
Private student loans | 477 | | | $ | 8 | | | 1,916 | | | $ | 35 | | | 6,742 | | | $ | 124 | |
Personal loans | 4,066 | | | $ | 51 | | | 8,805 | | | $ | 114 | | | 10,945 | | | $ | 147 | |
| | | | | | | | | | | |
(1)Accounts that entered a credit card TDR program include $351 million, $670 million and $741 million that were converted from revolving line-of-credit arrangements to term loans during the years ended December 31, 2021, 2020 and 2019, respectively.
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 year ended December 31, 2021, when compared to the same period in 2020. The decrease is primarily due to the impacts of government stimulus and disaster relief programs, which reduced the need for the Company’s customers to enroll in a loan modification program. The number and balance of loan modifications across all products, including the combined total of those identified as TDRs and those exempt from the TDR designation, during the year ended December 31, 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 in early 2020.
The following table presents the carrying value of loans that experienced a default during the period that had been modified in a TDR during the 15 months preceding the end of each period (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| For the Years Ended December 31, |
| 2021 | | 2020 | | 2019 |
| Number of Accounts | | Aggregated Outstanding Balances Upon Default | | Number of Accounts | | Aggregated Outstanding Balances Upon Default | | Number of Accounts | | Aggregated Outstanding Balances Upon Default |
TDRs that subsequently defaulted | | | | | | | | | | | |
Credit card loans(1)(2) | 17,953 | | | $ | 104 | | | 48,075 | | | $ | 276 | | | 71,326 | | | $ | 410 | |
Private student loans(3) | 290 | | | $ | 6 | | | 1,119 | | | $ | 22 | | | 1,406 | | | $ | 27 | |
Personal loans(2) | 1,589 | | | $ | 22 | | | 3,145 | | | $ | 46 | | | 4,152 | | | $ | 59 | |
| | | | | | | | | | | |
(1)For credit card loans that default from a temporary loan modification program, accounts revert back to the pre-modification terms and charging privileges remain suspended in most cases.
(2)For credit card loans and personal loans, a customer defaults from a loan modification program after either two consecutive missed payments or at charge-off, depending on the program. The outstanding balance upon default is generally the loan balance at the end of the month prior to default.
(3)For student loans, a customer defaults from a loan modification after they are 60 or more days delinquent. The outstanding balance upon default is generally the loan balance at the end of the month prior to default.
Of the account balances that defaulted as shown above for the years ended December 31, 2021, 2020 and 2019, approximately 66%, 53% and 38%, respectively, of the total balances were charged off at the end of the month in which they defaulted from a TDR program. For accounts that have defaulted from a TDR program and have not been subsequently charged off, the balances are included in the allowance for credit loss analysis discussed above under “— Allowance for Credit Losses.”
Geographical Distribution of Loans
The Company originates credit card loans throughout the U.S. The geographic distribution of the Company’s credit card loan receivables was as follows (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, |
| 2021 | | 2020 |
| $ | | % | | $ | | % |
Texas | $ | 6,543 | | | 8.8 | % | | $ | 6,182 | | | 8.6 | % |
California | 6,334 | | | 8.5 | | | 6,273 | | | 8.8 | |
Florida | 5,199 | | | 7.0 | | | 4,931 | | | 6.9 | |
New York | 4,908 | | | 6.6 | | | 4,836 | | | 6.8 | |
Illinois | 3,838 | | | 5.2 | | | 3,714 | | | 5.2 | |
Pennsylvania | 3,757 | | | 5.1 | | | 3,616 | | | 5.1 | |
Ohio | 3,149 | | | 4.2 | | | 3,005 | | | 4.2 | |
New Jersey | 2,599 | | | 3.5 | | | 2,558 | | | 3.6 | |
Georgia | 2,328 | | | 3.1 | | | 2,204 | | | 3.1 | |
Michigan | 2,081 | | | 2.8 | | | 1,983 | | | 2.8 | |
Other | 33,633 | | | 45.2 | | | 32,170 | | | 44.9 | |
Total credit card loans | $ | 74,369 | | | 100.0 | % | | $ | 71,472 | | | 100.0 | % |
| | | | | | | |
The Company originates private student, personal and other loans throughout the U.S. The geographic distribution of private student, personal and other loan receivables was as follows (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, |
| 2021 | | 2020 |
| $ | | % | | $ | | % |
New York | $ | 1,771 | | | 9.2 | % | | $ | 1,797 | | | 9.5 | % |
California | 1,686 | | | 8.7 | | | 1,706 | | | 9.0 | |
Pennsylvania | 1,341 | | | 6.9 | | | 1,317 | | | 6.9 | |
Texas | 1,305 | | | 6.8 | | | 1,224 | | | 6.4 | |
Illinois | 1,162 | | | 6.0 | | | 1,163 | | | 6.1 | |
New Jersey | 1,009 | | | 5.2 | | | 1,002 | | | 5.3 | |
Florida | 1,017 | | | 5.3 | | | 975 | | | 5.1 | |
Ohio | 770 | | | 4.0 | | | 758 | | | 4.0 | |
Massachusetts | 583 | | | 3.0 | | | 588 | | | 3.1 | |
Michigan | 599 | | | 3.1 | | | 585 | | | 3.1 | |
Other | 8,072 | | | 41.8 | | | 7,862 | | | 41.5 | |
Total other loans | $ | 19,315 | | | 100.0 | % | | $ | 18,977 | | | 100.0 | % |
| | | | | | | |
5. Credit Card and Private Student Loan Securitization Activities
The Company’s securitizations are accounted for as secured borrowings and the related trusts are treated as consolidated subsidiaries of the Company. For a description of the Company’s principles of consolidation with respect to VIEs, see Note 1: Background and Basis of Presentation.
Credit Card Securitization Activities
The Company accesses the term asset securitization market through DCMT and DCENT. Credit card loan receivables are transferred into DCMT and beneficial interests in DCMT are transferred into DCENT. DCENT issues debt securities to investors that are reported primarily in long-term borrowings.
The DCENT debt structure consists of four classes of securities (DiscoverSeries Class A, B, C and D notes), with the most senior class generally receiving a triple-A rating. To issue senior, higher-rated classes of notes, it is necessary to obtain the appropriate amount of credit enhancement, generally through the issuance of junior, lower-rated or more highly subordinated classes of notes. Wholly-owned subsidiaries of Discover Bank hold the subordinated classes of notes. The Company is exposed to credit risk associated with trust receivables as of the balance sheet date through the retention of these subordinated interests. The current expected credit loss (“CECL”) on trust receivables is included in the allowance for credit losses estimate.
The Company’s retained interests in the trust’s assets, consisting of investments in DCENT notes held by subsidiaries of Discover Bank, constitute intercompany positions that are eliminated in the preparation of the Company’s consolidated statements of financial condition.
Upon transfer of credit card loan receivables to the trust, the receivables and certain cash flows derived from them become restricted for use in meeting obligations to the trust’s creditors. Further, the transferred credit card loan receivables are owned by the trust and are not available to the Company’s third-party creditors. The trusts have ownership of cash balances, the amounts of which are reported in restricted cash within the Company’s consolidated statements of financial condition. Except for the seller’s interest in trust receivables, the Company’s interests in trust assets are generally subordinate to the interests of third-party investors in trust debt and, as such, may not be realized by the Company if needed to absorb deficiencies in cash flows that are allocated to those investors. Apart from the restricted assets related to securitization activities, the investors and the securitization trusts have no recourse to the Company’s other assets or the Company’s general credit for a shortage in cash flows.
The carrying values of these restricted assets, which are presented on the Company’s consolidated statements of financial condition as relating to securitization activities, are shown in the following table (dollars in millions): | | | | | | | | | | | |
| December 31, |
| 2021 | | 2020 |
Restricted cash | $ | 2,574 | | | $ | 16 | |
| | | |
Investors’ interests held by third-party investors | 9,425 | | | 10,600 | |
Investors’ interests held by wholly-owned subsidiaries of Discover Bank | 3,899 | | | 6,121 | |
Seller’s interest | 11,918 | | | 10,575 | |
Loan receivables(1) | 25,242 | | | 27,296 | |
Allowance for credit losses allocated to securitized loan receivables(1) | (1,371) | | | (1,936) | |
Net loan receivables | 23,871 | | | 25,360 | |
Other assets | 3 | | | 3 | |
Carrying value of assets of consolidated variable interest entities | $ | 26,448 | | | $ | 25,379 | |
| | | |
(1)The Company maintains its allowance for credit losses at an amount equal to lifetime expected credit losses associated with all loan receivables, which includes all loan receivables in the trusts. Therefore, the credit risk associated with the transferred receivables is fully reflected on the Company’s statements of financial condition in accordance with GAAP.
The debt securities issued by the consolidated trusts are subject to credit, payment and interest rate risks on the transferred credit card loan receivables. To protect investors in the securities, there are certain features or triggering events that will cause an early amortization of the debt securities, including triggers related to the impact of the performance of the trust receivables on the availability and adequacy of cash flows to meet contractual requirements. As of December 31, 2021, no economic or other early amortization events have occurred.
The Company continues to own and service the accounts that generate the loan receivables held by the trusts. Discover Bank receives servicing fees from the trusts based on a percentage of the monthly investor principal balance outstanding. Although the fee income to Discover Bank offsets the fee expense to the trusts and thus is eliminated in consolidation, failure to service the transferred loan receivables in accordance with contractual requirements could lead to a termination of the servicing rights and the loss of future servicing income, net of related expenses.
Private Student Loan Securitization Activities
Private student loan trust receivables are reported in loan receivables and the related debt issued by the trust is reported in long-term borrowings. The trust assets are restricted from being sold or pledged as collateral for other borrowings and the cash flows from these restricted assets may be used only to pay obligations of the trusts. Except for the trust’s restricted assets, the trust and investors have no recourse to the Company’s other assets or the Company’s general credit for a shortage in cash flows.
Principal payments on the long-term secured borrowings are made as cash is collected on the underlying loans that are collateral on the secured borrowings. The Company does not have access to cash collected by the securitization trust until cash is released in accordance with the trust indenture agreement. Similar to the credit card securitizations, the Company continues to own and service the private student loan receivables held by the trust and receives servicing fees from the trust based on a percentage of the principal balance outstanding. Although the servicing fee income offsets the fee expense related to the trust and thus is eliminated in consolidation, failure to service the transferred loan receivables in accordance with contractual requirements could lead to a termination of the servicing rights and the loss of future servicing income, net of related expenses.
Under terms of the trust arrangement, the Company has the option, but not the obligation, to provide financial support to the trust, but has never provided such support. A substantial portion of the credit risk associated with the securitized loans has been transferred to a third party under an indemnification arrangement.
The carrying values of these restricted assets, which are presented on the Company’s consolidated statements of financial condition as relating to securitization activities, are shown in the following table (dollars in millions): | | | | | | | | | | | |
| December 31, |
| 2021 | | 2020 |
Restricted cash | $ | 8 | | | $ | 9 | |
Private student loan receivables | 207 | | | 250 | |
Carrying value of assets of consolidated variable interest entities | $ | 215 | | | $ | 259 | |
| | | |
6. Premises and Equipment
A summary of premises and equipment, net is as follows (dollars in millions): | | | | | | | | | | | |
| December 31, |
| 2021 | | 2020 |
Land | $ | 38 | | | $ | 38 | |
Buildings and improvements | 676 | | | 673 | |
Furniture, fixtures and equipment | 1,126 | | | 1,125 | |
Software | 992 | | | 901 | |
Premises and equipment | 2,832 | | | 2,737 | |
Less: accumulated depreciation | (1,415) | | | (1,349) | |
Less: accumulated amortization of software | (434) | | | (361) | |
Premises and equipment, net | $ | 983 | | | $ | 1,027 | |
| | | |
Depreciation expense was $86 million, $98 million and $84 million for the years ended December 31, 2021, 2020 and 2019, respectively. Amortization expense on capitalized software was $103 million, $100 million and $80 million for the years ended December 31, 2021, 2020 and 2019, respectively.
7. Goodwill and Intangible Assets
Goodwill
As of December 31, 2021 and 2020, the Company had goodwill of $255 million related to PULSE, which is part of the Payment Services segment. The Company conducted its annual goodwill impairment test as of October 1, 2021 and 2020 and no impairment charges were identified.
Intangible Assets
The Company’s amortizable intangible assets consisting of customer relationships and trade names resulted from various acquisitions and are primarily included in the Payment Services segment. As of December 31, 2021, the amortizable intangible assets had no remaining net carrying value. As of December 31, 2020, the total gross carrying amount and accumulated amortization of these intangible assets was $77 million and $74 million, respectively, resulting in a net carrying value of $3 million.
Non-amortizable intangible assets consist primarily of trade name intangibles and international transaction processing rights included in the Payment Services segment.
In the second quarter of 2020, the Company conducted an interim impairment test on its non-amortizable intangible assets, both the Diners Club trade names and international transaction processing rights, due to changes in the international travel and entertainment businesses and a declining revenue outlook for the foreseeable future resulting from the COVID-19 pandemic. The valuation methodology used to value the trade names and international transaction processing rights was based on a discounted cash flow method, consistent with the methodology used for annual impairment testing. As a result of this analysis, the Company determined that the trade names and international transaction processing rights were impaired and recognized charges in its Payment Services segment of $36 million and $23 million, respectively. The impairments were recorded in other expense on the consolidated statements of income.
In the second quarter of 2021, global travel and entertainment spending continued to trend lower than pre-pandemic levels. As a result, the Company re-evaluated the impact on the value of the Diners Club trade names by conducting an interim impairment test on the asset in conjunction with the preparation of the financial statements. The valuation methodology used to value the trade names was based on a discounted cash flow method, consistent with the method used for annual impairment testing. As a result of this analysis, the Company determined that the trade names were fully impaired and recognized a charge, in the second quarter of 2021, in its Payment Services segment of $92 million. The impairment was recorded in other expense.
As of December 31, 2021, the non-amortizable intangible assets had no remaining net carrying value. The net carrying value of these intangible assets was $92 million as of December 31, 2020.
Amortization expense related to the Company’s intangible assets was not material for the years ended December 31, 2021, 2020 and 2019. As of December 31, 2021, no intangible asset balances remain to be amortized.
8. Deposits
The Company offers its 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.
Customer deposits held with Discover Bank are currently insured for up to $250,000 per account holder through the Federal Deposit Insurance Corporation (“FDIC”). At December 31, 2021 and 2020, the Company had approximately $8.2 billion and $7.3 billion of uninsured deposits, respectively. Uninsured deposits are the portion of deposit accounts in U.S. offices that exceed the FDIC insurance limit or similar state deposit insurance regime, and amounts in any other uninsured investment or deposit accounts that are classified as deposits and not subject to any federal or state deposit insurance regime. As it is not reasonably practicable for the Company to provide a precise measure of uninsured deposits, the amounts of uninsured deposits above were estimated based on the same methodologies and assumptions used for Discover Bank’s regulatory reporting requirements.
The following table summarizes certificates of deposit in uninsured accounts and accounts that are in excess of the FDIC insurance limit by time remaining until maturity (dollars in millions): | | | | | |
| At December 31, 2021 |
Three months or less | $ | 157 | |
Over three months through six months | 104 | |
Over six months through twelve months | 187 | |
Over twelve months | 86 | |
Total | $ | 534 | |
| |
The following table summarizes certificates of deposit maturing over each of the next five years and thereafter (dollars in millions): | | | | | |
| At December 31, 2021 |
2022 | $ | 14,214 | |
2023 | 2,944 | |
2024 | 1,499 | |
2025 | 872 | |
2026 | 860 | |
Thereafter | 736 | |
Total | $ | 21,125 | |
| |
9. Long-Term Borrowings
Long-term borrowings consist of borrowings having original maturities of one year or more. The following table provides a summary of the Company’s long-term borrowings and weighted-average interest rates on outstanding balances (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, |
| 2021 | | 2020 |
| Maturity | | Interest Rate | | Weighted-Average Interest Rate | | Outstanding Amount | | Outstanding Amount |
Securitized Debt | | | | | | | | | |
Fixed-rate asset-backed securities(1) | 2022-2026 | | 0.58% - 3.04% | | 2.01% | | $ | 5,588 | | | $ | 6,041 | |
Floating-rate asset-backed securities(2) | 2022-2024 | | 0.44% - 0.71% | | 0.56% | | 3,347 | | | 4,669 | |
Total Discover Card Master Trust I and Discover Card Execution Note Trust | | | | | | | 8,935 | | | 10,710 | |
| | | | | | | | | |
Floating-rate asset-backed security(3)(4) | 2031 | | 4.25% | | 4.25% | | 104 | | | 130 | |
Total student loan securitization trust | | | | | | | 104 | | | 130 | |
Total long-term borrowings - owed to securitization investors | | | | | | | 9,039 | | | 10,840 | |
| | | | | | | | | |
Discover Financial Services (Parent Company) | | | | | | | | | |
Fixed-rate senior notes | 2022-2027 | | 3.75% - 5.20% | | 4.16% | | 3,382 | | | 3,337 | |
Fixed-rate retail notes | 2022-2031 | | 2.85% - 4.40% | | 3.75% | | 166 | | | 336 | |
| | | | | | | | | |
Discover Bank | | | | | | | | | |
Fixed-rate senior bank notes(1) | 2023-2030 | | 2.45% - 4.65% | | 3.63% | | 5,385 | | | 6,213 | |
Fixed-rate subordinated bank notes(1) | 2028 | | 4.68% | | 4.68% | | 505 | | | 515 | |
Total long-term borrowings | | | | | | | $ | 18,477 | | | $ | 21,241 | |
| | | | | | | | | |
(1)The Company uses interest rate swaps to hedge portions of these long-term borrowings against changes in fair value attributable to changes in London Interbank Offered Rate (“LIBOR”) or Federal Funds Overnight Index Swap (“OIS”) rate. Use of these interest rate swaps impacts carrying value of the debt. See Note 21: Derivatives and Hedging Activities.
(2)Discover Card Execution Note Trust floating-rate asset-backed securities include issuances with the following interest rate terms: 1-month LIBOR + 33 to 60 basis points as of December 31, 2021.
(3)The student loan securitization trust floating-rate asset-backed security includes an issuance with the following interest rate term: Prime rate + 100 basis points as of December 31, 2021.
(4)Repayment of this debt is dependent upon the timing of principal and interest payments on the underlying student loans. The date shown represents final maturity date.
The following table summarizes long-term borrowings maturing over each of the next five years and thereafter (dollars in millions): | | | | | |
| At December 31, 2021 |
2022 | $ | 5,185 | |
2023 | 3,312 | |
2024 | 3,731 | |
2025 | 529 | |
2026 | 2,676 | |
Thereafter | 3,044 | |
Total | $ | 18,477 | |
| |
As a member of the FHLB of Chicago, the Company has access to both short- and long-term advance structures with maturities ranging from overnight to 30 years. As of December 31, 2021, the Company had total committed borrowing capacity of $1.4 billion based on the amount and type of assets pledged, of which $1.3 billion of short-term
advances were outstanding with the FHLB of Chicago. These advances are presented as short-term borrowings on the consolidated statements of financial condition.
Additionally, the Company has access to committed borrowing capacity through private securitizations to support the funding of its credit card loan receivables. These commitments provide for both short- and long-term borrowings. As of December 31, 2021, the total commitment of secured credit facilities through private providers was $4.0 billion, $500 million of which was outstanding as a short-term draw at December 31, 2021. This advance is presented as short-term borrowings on the consolidated statements of financial condition. Access to the unused portions of the secured credit facilities is subject to the terms of the agreements with each of the providers. The secured credit facilities have various expirations in 2023. Borrowings outstanding under each facility bear interest at a margin above LIBOR or the asset-backed commercial paper costs of each provider. The terms of each agreement provide for a commitment fee to be paid on the unused capacity and include various affirmative and negative covenants, including performance metrics and legal requirements similar to those required to issue any term securitization transaction.
10. Stock-Based Compensation Plans
The Company has two stock-based compensation plans: the Discover Financial Services Omnibus Incentive Plan (“Omnibus Plan”) and the Discover Financial Services Directors’ Compensation Plan (“Directors’ Compensation Plan”).
Omnibus Plan
The Omnibus Plan, which is stockholder-approved, provides for the award of stock options, stock appreciation rights, restricted stock, restricted stock units (“RSUs”), performance stock units (“PSUs”) and other stock-based and/or cash awards (collectively, “awards”). Currently, the Company does not have any stock options, stock appreciation rights or restricted stock outstanding. The total number of shares that may be granted is 45 million shares, subject to adjustments for certain transactions as described in the Omnibus Plan document. Shares granted under the Omnibus Plan may be the following: (i) authorized but unissued shares and (ii) treasury shares that the Company acquires in the open market, in private transactions or otherwise.
Directors’ Compensation Plan
The Directors’ Compensation Plan, which is stockholder-approved, permits the grant of RSUs to non-employee directors. Under the Directors’ Compensation Plan, the Company may issue awards of up to a total of 1 million shares of common stock to non-employee directors. Shares of stock that are issuable pursuant to the awards granted under the Directors’ Compensation Plan may be one of the following: authorized but unissued shares, treasury shares or shares that the Company acquires in the open market. Annual awards for eligible directors are calculated by dividing $150,000 by the fair market value of a share of stock on the date of grant and are subject to a restriction period whereby 100% of such units shall vest in full on the earlier of the one year anniversary of the date of grant or immediately prior to the first annual meeting of shareholders following the date of grant. RSUs include the right to receive dividend equivalents in the same amount and at the same time as dividends paid to all Company common shareholders.
Stock-Based Compensation
The following table details the compensation cost, net of forfeitures (dollars in millions): | | | | | | | | | | | | | | | | | |
| For the Years Ended December 31, |
| 2021 | | 2020 | | 2019 |
RSUs | $ | 46 | | | $ | 49 | | | $ | 49 | |
PSUs(1) | 57 | | | (8) | | | 20 | |
Total stock-based compensation expense | $ | 103 | | | $ | 41 | | | $ | 69 | |
| | | | | |
Income tax benefit | $ | 15 | | | $ | 9 | | | $ | 12 | |
| | | | | |
(1)Total PSU expense for the year ended December 31, 2021, includes an incremental $1 million, representing a modification to the 2019 PSU award. Total PSU expense for the year ended December 31, 2020, includes an incremental $2 million, representing a modification to the 2018 PSU award. The nature of the modifications was to adjust the payout to compensate for the 2020 CECL adoption impact on earnings per share (“EPS”).
RSUs
The following table sets forth the activity related to vested and unvested RSUs: | | | | | | | | | | | | | | | | | |
| Number of Units | | Weighted-Average Remaining Contractual Term (in years) | | Aggregate Intrinsic Value (in millions) |
RSUs at December 31, 2020 | 1,934,399 | | | | | $ | 175 | |
Granted | 622,107 | | | | | |
Conversions to common stock | (668,418) | | | | | |
Forfeited | (71,844) | | | | | |
RSUs at December 31, 2021 | 1,816,244 | | | 0.87 | | $ | 210 | |
Vested and convertible RSUs at December 31, 2021 | 744,477 | | | 0.00 | | $ | 86 | |
| | | | | |
The following table sets forth the activity related to unvested RSUs: | | | | | | | | | | | |
| Number of Units | | Weighted-Average Grant-Date Fair Value |
Unvested RSUs at December 31, 20201) | 954,083 | | | $ | 74.58 | |
Granted | 622,107 | | | $ | 101.47 | |
Vested | (613,862) | | | $ | 77.12 | |
Forfeited | (71,844) | | | $ | 89.57 | |
Unvested RSUs at December 31, 2021(1) | 890,484 | | | $ | 90.40 | |
| | | |
(1)Unvested RSUs represent awards where recipients have yet to satisfy either explicit vesting terms or retirement-eligibility requirements.
Compensation cost associated with RSUs is determined based on the number of units granted and the fair value on the date of grant. The fair value is amortized on a straight-line basis, net of estimated forfeitures, over the requisite service period for each separately vesting tranche of the award. The requisite service period is generally the vesting period.
The following table summarizes the total intrinsic value of the RSUs converted to common stock and the total grant-date fair value of RSUs vested (dollars in millions, except weighted-average grant-date fair value amounts): | | | | | | | | | | | | | | | | | |
| For the Years Ended December 31, |
| 2021 | | 2020 | | 2019 |
Intrinsic value of RSUs converted to common stock | $ | 62 | | | $ | 55 | | | $ | 93 | |
Grant-date fair value of RSUs vested | $ | 47 | | | $ | 51 | | | $ | 48 | |
Weighted-average grant-date fair value of RSUs granted | $ | 101.47 | | | $ | 76.58 | | | $ | 73.52 | |
| | | | | |
As of December 31, 2021, there was $32 million of total unrecognized compensation cost related to non-vested RSUs. The cost is expected to be recognized over a weighted-average period of 0.89 years.
RSUs provide for accelerated vesting if there is a change in control or upon certain terminations (as defined in the Omnibus Plan or the award certificate). RSUs include the right to receive dividend equivalents in the same amount and at the same time as dividends paid to all Company common shareholders.
PSUs
The following table sets forth the activity related to vested and unvested PSUs: | | | | | | | | | | | | | | | | | | | | | | | |
| Number of Units | | Weighted-Average Grant-Date Fair Value | | Weighted-Average Remaining Contractual Term (in years) | | Aggregate Intrinsic Value (in millions) |
PSUs at December 31, 2020(1) | 728,728 | | | $ | 79.01 | | | | | $ | 66 | |
Granted | 268,574 | | | $ | 94.21 | | | | | |
Conversions to common stock | (225,182) | | | $ | 77.75 | | | | | |
Forfeited | (7,985) | | | $ | 79.90 | | | | | |
PSUs at December 31, 2021(1)(2)(3)(4) | 764,135 | | | $ | 84.58 | | | 1.15 | | $ | 88 | |
| | | | | | | |
(1) All PSUs outstanding at December 31, 2021 and December 31, 2020, are unvested PSUs.
(2) Includes 211,799 PSUs granted in 2019 that are earned based on the Company’s cumulative EPS as measured over the three-year performance period which ended December 31, 2021, and are subject to the requisite service period, which ended February 1, 2022.
(3) Includes 290,532 PSUs granted in 2020 that are earned based on the Company’s cumulative EPS as measured over the three-year performance period which ends December 31, 2022, and are subject to the requisite service period, which ends February 1, 2023.
(4) Includes 261,804 PSUs granted in 2021 that may be earned based on the Company’s cumulative EPS as measured over the three-year performance period which ends December 31, 2023, and are subject to the requisite service period, which ends February 1, 2024.
Compensation cost associated with PSUs is determined based on the number of instruments granted, the fair value on the date of grant and the performance factor. The fair value is amortized on a straight-line basis, net of estimated forfeitures, over the requisite service period. Each PSU outstanding at December 31, 2021, is a restricted stock instrument that is subject to additional conditions and constitutes a contingent and unsecured promise by the Company to pay up to 1.5 shares per unit of the Company’s common stock on the conversion date for the PSU, contingent on the number of PSUs to be issued. PSUs have a performance period of three years and a vesting period of three years. The requisite service period of an award having both performance and service conditions is the longest of the explicit, implicit and derived service periods.
The following table summarizes the total intrinsic value of the PSUs converted to common stock and the total grant-date fair value of PSUs vested (dollars in millions, except weighted-average grant-date fair value amounts): | | | | | | | | | | | | | | | | | |
| For the Years Ended December 31, |
| 2021 | | 2020 | | 2019 |
Intrinsic value of PSUs converted to common stock | $ | 15 | | | $ | 21 | | | $ | 33 | |
Grant-date fair value of PSUs vested | $ | 18 | | | $ | 17 | | | $ | 21 | |
Weighted-average grant-date fair value of PSUs granted | $ | 94.21 | | | $ | 85.25 | | | $ | 71.62 | |
| | | | | |
As of December 31, 2021, there was $19 million of total unrecognized compensation cost related to non-vested PSUs. The cost is expected to be recognized over a weighted-average period of 1.3 years.
PSUs provide for accelerated vesting if there is a change in control or upon certain terminations (as defined in the Omnibus Plan or the award certificate). PSUs include the right to receive dividend equivalents, which will accumulate and pay out in cash if and when the underlying shares are issued.
11. Employee Benefit Plans
The Company sponsors the Discover Financial Services Pension Plan (the “Discover Pension Plan”), which is a non-contributory defined benefit plan that is qualified under Section 401(a) of the Internal Revenue Code, for eligible employees in the U.S. Effective December 31, 2008, the Discover Pension Plan was amended to discontinue the accrual of future benefits. The Company also sponsors the Discover Financial Services 401(k) Plan (the “Discover 401(k) Plan”), which is a defined contribution plan that is qualified under Section 401(a) of the Internal Revenue Code, for its eligible U.S. employees.
Discover Pension Plan
The Discover Pension Plan generally provides retirement benefits that are based on each participant’s years of credited service prior to 2009 and on compensation specified in the Discover Pension Plan. The Company’s policy is to
fund at least the amounts sufficient to meet minimum funding requirements under the Employee Retirement Income Security Act of 1974, as amended. Net periodic benefit cost (income) is recorded in employee compensation and benefits within the consolidated statements of income. For this plan, the net periodic benefit cost was immaterial for all periods presented.
The Company recognizes the funded status of the defined benefit pension plan, measured as the difference between the fair value of plan assets and the projected benefit obligation, in accrued expenses and other liabilities on the consolidated statements of financial condition. As of December 31, 2021 and 2020, the unfunded status related to the defined benefit pension plan was $106 million and $134 million, respectively. The Company does not expect to make any contributions to the Discover Pension Plan in 2022. Expected benefit payments from the Discover Pension Plan for each of the next five years range from $19 million and $25 million annually.
Discover 401(k) Plan
Under the Discover 401(k) Plan, eligible U.S. employees receive 401(k) matching contributions. Eligible employees also receive fixed employer contributions. The pretax expense associated with the Company contributions for the years ended December 31, 2021, 2020 and 2019 was $97 million, $99 million and $87 million, respectively.
12. Common and Preferred Stock
Common Stock Repurchase Program
In January 2021, the Board of Directors approved a new share repurchase program authorizing up to $1.1 billion of share repurchases. The program was scheduled to expire on December 31, 2021. On July 20, 2021, the Company’s Board of Directors approved a share repurchase program authorizing the repurchase of up to $2.4 billion of its outstanding shares of common stock, which replaced the previous share repurchase program. The program expires on March 31, 2022. During the three months ended December 31, 2021, the Company repurchased approximately 6.5 million shares for approximately $770 million. During the year ended December 31, 2021, the Company repurchased approximately 18.9 million shares for approximately $2.2 billion.
Preferred Stock
The table below presents a summary of the Company's non-cumulative perpetual preferred stock that is outstanding at December 31, 2021 (dollars in millions, except per depositary share amounts):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Series | | Description | | Initial Issuance Date | | Liquidation Preference and Redemption Price per Depositary Share(1) | | Per Annum Dividend Rate in effect at December 31, 2021 | | Total Depositary Shares Authorized, Issued and Outstanding | | Carrying Value |
| | | | | December 31, 2021 | | December 31, 2020 | | December 31, 2021 | | December 31, 2020 |
C(2)(3)(4) | | Fixed-to-Floating Rate | | 10/31/2017 | | $ | 1,000 | | | 5.500 | % | | 570,000 | | | 570,000 | | | $ | 563 | | | $ | 563 | |
D(2)(5)(6) | | Fixed-Rate Reset | | 6/22/2020 | | $ | 1,000 | | | 6.125 | % | | 500,000 | | | 500,000 | | | 493 | | | 493 | |
Total Preferred Stock | | 1,070,000 | | | 1,070,000 | | | $ | 1,056 | | | $ | 1,056 | |
| | | | | | | | | | | | | | | | |
(1)Redeemable at the redemption price plus declared and unpaid dividends.
(2)Issued as depositary shares, each representing 1/100th interest in a share of the corresponding series of preferred stock. Each preferred share has a par value of $0.01.
(3)Redeemable at the Company’s option, subject to regulatory approval, either (i) in whole or in part on any dividend payment date on or after October 30, 2027, or (ii) in whole but not in part, at any time within 90 days following a regulatory capital treatment event (as defined in the certificate of designations for the Series C preferred stock).
(4)Any dividends declared are payable semi-annually in arrears at a rate of 5.50% per annum until October 30, 2027. Thereafter, dividends declared will be payable quarterly in arrears at a floating rate equal to 3-month LIBOR plus a spread of 3.076% per annum.
(5)Redeemable at the Company’s option, subject to regulatory approval, either (i) in whole or in part during the three-month period prior to, and including, each reset date (as defined in the certificate of designations for the Series D preferred stock) or (ii) in whole but not in part, at any time within 90 days following a regulatory capital treatment event (as defined in the certificate of designations for the Series D Preferred Stock).
(6)Any dividends declared are payable semi-annually in arrears at a rate of 6.125% per annum until September 23, 2025, after which the dividend rate will reset every 5 years to a fixed annual rate equal to the 5-year Treasury plus a spread of 5.783%.
13. Accumulated Other Comprehensive Income
Changes in each component of AOCI were as follows (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | |
| Unrealized Gains on Available-for-Sale Investment Securities, Net of Tax | | (Losses) Gains on Cash Flow Hedges, Net of Tax | | Losses on Pension Plan, Net of Tax | | AOCI |
For the Year Ended December 31, 2021 | | | | | | | |
Balance at December 31, 2020 | $ | 284 | | | $ | (12) | | | $ | (227) | | | $ | 45 | |
Net change | (170) | | | 3 | | | 28 | | | (139) | |
Balance at December 31, 2021 | $ | 114 | | | $ | (9) | | | $ | (199) | | | $ | (94) | |
| | | | | | | |
For the Year Ended December 31, 2020 | | | | | | | |
Balance at December 31, 2019 | $ | 112 | | | $ | (17) | | | $ | (214) | | | $ | (119) | |
| | | | | | | |
Net change | 172 | | | 5 | | | (13) | | | 164 | |
Balance at December 31, 2020 | $ | 284 | | | $ | (12) | | | $ | (227) | | | $ | 45 | |
| | | | | | | |
For the Year Ended December 31, 2019 | | | | | | | |
Balance at December 31, 2018 | $ | 10 | | | $ | 22 | | | $ | (188) | | | $ | (156) | |
| | | | | | | |
Net change | 102 | | | (39) | | | (26) | | | 37 | |
Balance at December 31, 2019 | $ | 112 | | | $ | (17) | | | $ | (214) | | | $ | (119) | |
| | | | | | | |
The following table presents each component of OCI before reclassifications and amounts reclassified from AOCI for each component of OCI before- and after-tax (dollars in millions): | | | | | | | | | | | | | | | | | |
| Before Tax | | Tax Benefit (Expense) | | Net of Tax |
For the Year Ended December 31, 2021 | | | | | |
Available-for-Sale Investment Securities | | | | | |
Net unrealized holding losses arising during the period | $ | (226) | | | $ | 56 | | | $ | (170) | |
| | | | | |
Net change | $ | (226) | | | $ | 56 | | | $ | (170) | |
Cash Flow Hedges | | | | | |
Net unrealized losses arising during the period | $ | (1) | | | $ | 1 | | | $ | — | |
Amounts reclassified from AOCI | 3 | | | — | | | 3 | |
Net change | $ | 2 | | | $ | 1 | | | $ | 3 | |
Pension Plan | | | | | |
Unrealized gains arising during the period | $ | 37 | | | $ | (9) | | | $ | 28 | |
Net change | $ | 37 | | | $ | (9) | | | $ | 28 | |
| | | | | |
For the Year Ended December 31, 2020 | | | | | |
Available-for-Sale Investment Securities | | | | | |
Net unrealized holding gains arising during the period | $ | 227 | | | $ | (55) | | | $ | 172 | |
| | | | | |
Net change | $ | 227 | | | $ | (55) | | | $ | 172 | |
Cash Flow Hedges | | | | | |
Net unrealized losses arising during the period | $ | (7) | | | $ | 3 | | | $ | (4) | |
Amounts reclassified from AOCI | 12 | | | (3) | | | 9 | |
Net change | $ | 5 | | | $ | — | | | $ | 5 | |
Pension Plan | | | | | |
Unrealized losses arising during the period | $ | (17) | | | $ | 4 | | | $ | (13) | |
Net change | $ | (17) | | | $ | 4 | | | $ | (13) | |
| | | | | |
For the Year Ended December 31, 2019 | | | | | |
Available-for-Sale Investment Securities | | | | | |
Net unrealized holding gains arising during the period | $ | 135 | | | $ | (33) | | | $ | 102 | |
| | | | | |
Net change | $ | 135 | | | $ | (33) | | | $ | 102 | |
Cash Flow Hedges | | | | | |
Net unrealized losses arising during the period | $ | (42) | | | $ | 7 | | | $ | (35) | |
Amounts reclassified from AOCI | (5) | | | 1 | | | (4) | |
Net change | $ | (47) | | | $ | 8 | | | $ | (39) | |
Pension Plan | | | | | |
Unrealized losses arising during the period | $ | (34) | | | $ | 8 | | | $ | (26) | |
Net change | $ | (34) | | | $ | 8 | | | $ | (26) | |
| | | | | |
14. Other Expense
Total other expense includes the following components (dollars in millions): | | | | | | | | | | | | | | | | | |
| For the Years Ended December 31, |
| 2021 | | 2020 | | 2019 |
Postage | $ | 91 | | | $ | 93 | | | $ | 93 | |
Fraud losses and other charges | 92 | | | 96 | | | 96 | |
Supplies | 46 | | | 51 | | | 34 | |
Incentive expense | 44 | | | 57 | | | 84 | |
Impairment charges | 95 | | | 59 | | | — | |
Other expense | 252 | | | 240 | | | 196 | |
Total other expense | $ | 620 | | | $ | 596 | | | $ | 503 | |
| | | | | |
15. Income Taxes
Income tax expense consisted of the following (dollars in millions): | | | | | | | | | | | | | | | | | |
| For the Years Ended December 31, |
| 2021 | | 2020 | | 2019 |
Current | | | | | |
U.S. federal | $ | 1,084 | | | $ | 807 | | | $ | 836 | |
U.S. state and local | 204 | | | 159 | | | 175 | |
Total | 1,288 | | | 966 | | | 1,011 | |
Deferred | | | | | |
U.S. federal | 288 | | | (585) | | | (116) | |
U.S. state and local | 39 | | | (87) | | | (17) | |
Total | 327 | | | (672) | | | (133) | |
Income tax expense | $ | 1,615 | | | $ | 294 | | | $ | 878 | |
| | | | | |
The following table reconciles the Company’s effective tax rate to the U.S. federal statutory income tax rate: | | | | | | | | | | | | | | | | | |
| For the Years Ended December 31, |
| 2021 | | 2020 | | 2019 |
U.S. federal statutory income tax rate | 21.0 | % | | 21.0 | % | | 21.0 | % |
U.S. state, local and other income taxes, net of U.S. federal income tax benefits | 3.4 | | | 3.4 | | | 3.5 | |
| | | | | |
Tax credits | (1.2) | | | (4.4) | | | (1.4) | |
Other | (0.3) | | | 0.5 | | | (0.2) | |
Effective income tax rate | 22.9 | % | | 20.5 | % | | 22.9 | % |
| | | | | |
For the year ended December 31, 2021, income tax expense increased $1.3 billion, and the effective income tax rate increased 2.4 percentage points as compared to the year ended December 31, 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.
Income tax expense decreased $584 million, and the effective tax rate decreased 2.4 percentage points for the year ended December 31, 2020, as compared to the year ended December 31, 2019. The decrease in income tax expense was primarily driven by a decrease in pretax income. The effective tax rate decreased primarily due to tax credits having a higher rate benefit on lower pretax income.
Deferred income taxes reflect the net tax effects of temporary differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when such differences are expected to reverse. Valuation allowances are provided to reduce deferred tax assets to an amount that
is more likely than not to be realized. The Company evaluates the likelihood of realizing its deferred tax assets by estimating sources of future taxable income and the impact of tax planning strategies.
Significant components of the Company’s net deferred income taxes, which are included in other assets in the Company’s consolidated statements of financial condition, were as follows (dollars in millions): | | | | | | | | | | | |
| December 31, |
| 2021 | | 2020 |
Deferred tax assets | | | |
Allowance for credit losses | $ | 1,660 | | | $ | 1,997 | |
| | | |
Customer fees and rewards | 45 | | | — | |
Other | 158 | | | 157 | |
Total deferred tax assets before valuation allowance | 1,863 | | | 2,154 | |
Valuation allowance | (1) | | | (1) | |
Total deferred tax assets, net of valuation allowance | 1,862 | | | 2,153 | |
Deferred tax liabilities | | | |
Depreciation and software amortization | (167) | | | (172) | |
Unrealized gains | (125) | | | (90) | |
Customer fees and rewards | — | | | (37) | |
Deferred loan origination costs | (35) | | | (21) | |
| | | |
| | | |
Other | (41) | | | (58) | |
Total deferred tax liabilities | (368) | | | (378) | |
Net deferred tax assets | $ | 1,494 | | | $ | 1,775 | |
| | | |
A reconciliation of beginning and ending unrecognized tax benefits is as follows (dollars in millions): | | | | | | | | | | | | | | | | | |
| For the Years Ended December 31, |
| 2021 | | 2020 | | 2019 |
Balance at beginning of period | $ | 56 | | | $ | 61 | | | $ | 83 | |
Additions | | | | | |
Current year tax positions | 13 | | | 5 | | | 4 | |
Prior year tax positions | 8 | | | 3 | | | — | |
Reductions | | | | | |
Prior year tax positions | (14) | | | — | | | (22) | |
Settlements with taxing authorities | (14) | | | (2) | | | — | |
Expired statute of limitations | (10) | | | (11) | | | (4) | |
| | | | | |
| | | | | |
Balance at end of period(1) | $ | 39 | | | $ | 56 | | | $ | 61 | |
| | | | | |
(1)For the years ended December 31, 2021, 2020 and 2019, amounts included $37 million, $51 million and $54 million, respectively, of unrecognized tax benefits, which, if recognized, would favorably affect the effective tax rate.
The Company recognizes accrued interest and penalties related to unrecognized tax benefits as a component of income tax expense. Interest and penalties related to unrecognized tax benefits were $3 million and $12 million for the years ended December 31, 2021 and 2020, respectively.
The Company is subject to examination by the Internal Revenue Service (“IRS”) and tax authorities in various state, local and foreign tax jurisdictions. The IRS is examining the Company’s 2018 federal income tax filings. The Company regularly assesses the likelihood of additional assessments or settlements in each of the taxing jurisdictions. At this time, the potential change in unrecognized tax benefits is expected to be immaterial over the next 12 months. The Company believes that its reserves are sufficient to cover any tax, penalties and interest that would result from such examinations.
The Company has an immaterial amount of state net operating loss carryforwards that are subject to a partial valuation allowance as of December 31, 2021 and 2020.
16. Earnings Per Share
The following table presents the calculation of basic and diluted EPS (dollars in millions, except per share amounts): | | | | | | | | | | | | | | | | | |
| For the Years Ended December 31, |
| 2021 | | 2020 | | 2019 |
Numerator | | | | | |
Net income | $ | 5,449 | | | $ | 1,141 | | | $ | 2,957 | |
Preferred stock dividends | (69) | | | (31) | | | (31) | |
| | | | | |
Net income available to common stockholders | 5,380 | | | 1,110 | | | 2,926 | |
Income allocated to participating securities | (29) | | | (6) | | | (18) | |
Net income allocated to common stockholders | $ | 5,351 | | | $ | 1,104 | | | $ | 2,908 | |
| | | | | |
Denominator | | | | | |
Weighted-average shares of common stock outstanding | 300 | | | 307 | | | 320 | |
Effect of dilutive common stock equivalents | — | | | — | | | — | |
Weighted-average shares of common stock outstanding and common stock equivalents | 300 | | | 307 | | | 320 | |
| | | | | |
Basic earnings per common share | $ | 17.85 | | | $ | 3.60 | | | $ | 9.09 | |
Diluted earnings per common share | $ | 17.83 | | | $ | 3.60 | | | $ | 9.08 | |
| | | | | |
Anti-dilutive securities were not material and had no impact on the computation of diluted EPS for the years ended December 31, 2021, 2020 and 2019.
17. Capital Adequacy
DFS is subject to the capital adequacy guidelines of the Federal Reserve. Discover Bank, the Company’s banking subsidiary, is subject to various regulatory capital requirements as administered by the FDIC. Failure to meet minimum capital requirements can result in the initiation of certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could limit the Company’s business activities and have a direct material effect on the financial condition and operating results of DFS and Discover Bank. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, DFS and Discover Bank must meet specific risk-based capital requirements and leverage ratios that involve quantitative measures of assets, liabilities and certain off-balance sheet items, as calculated under regulatory guidelines. Capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
DFS and Discover Bank are subject to regulatory and capital rules issued by the Federal Reserve and FDIC, respectively, under the Basel Committee’s December 2010 framework (“Basel III rules”). Under the Basel III rules, DFS and Discover Bank are classified as “standardized approach” entities. Standardized approach entities are defined as U.S. banking organizations with consolidated total assets over $50 billion but not exceeding $250 billion and consolidated total on-balance sheet foreign exposure less than $10 billion.
On March 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, the Company has 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, which ended December 31, 2021, the estimated impact of CECL on regulatory capital will be phased in over three years beginning in 2022. Accordingly, the Company’s Common Equity Tier 1 (“CET1”) capital ratios in 2021 and 2020 are higher than they otherwise would have been. The Company's CET1 capital ratios will continue to be favorably impacted by this election over the three year phase-in period.
As of December 31, 2021 and 2020, DFS and Discover Bank met all Basel III minimum capital ratio requirements to which they were subject. DFS and Discover Bank also met the requirements to be considered “well-capitalized” under Regulation Y and prompt corrective action rules, respectively. There have been no conditions or events that management believes have changed DFS’ or Discover Bank’s category. To be categorized as “well-capitalized,” DFS and Discover Bank must maintain minimum capital ratios outlined in the table below.
The following table shows the actual capital amounts and ratios of DFS and Discover Bank and comparisons of each to the regulatory minimum and “well-capitalized” requirements (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Actual | | Minimum Capital Requirements | | Capital Requirements To Be Classified as Well-Capitalized |
| Amount | | Ratio(1) | | Amount | | Ratio | | Amount(2) | | Ratio(2) |
December 31, 2021 | | | | | | | | | | | |
Total capital (to risk-weighted assets) | | | | | | | | | | | |
Discover Financial Services | $ | 17,150 | | | 17.6 | % | | $ | 7,775 | | | ≥8.0% | | $ | 9,719 | | | ≥10.0% |
Discover Bank | $ | 15,957 | | | 16.9 | % | | $ | 7,573 | | | ≥8.0% | | $ | 9,466 | | | ≥10.0% |
Tier 1 capital (to risk-weighted assets) | | | | | | | | | | | |
Discover Financial Services | $ | 15,395 | | | 15.8 | % | | $ | 5,831 | | | ≥6.0% | | $ | 5,831 | | | ≥6.0% |
Discover Bank | $ | 13,932 | | | 14.7 | % | | $ | 5,680 | | | ≥6.0% | | $ | 7,573 | | | ≥8.0% |
Tier 1 capital (to average assets) | | | | | | | | | | | |
Discover Financial Services | $ | 15,395 | | | 13.9 | % | | $ | 4,432 | | | ≥4.0% | | N/A | | N/A |
Discover Bank | $ | 13,932 | | | 12.8 | % | | $ | 4,365 | | | ≥4.0% | | $ | 5,456 | | | ≥5.0% |
Common Equity Tier 1 (to risk-weighted assets) | | | | | | | | | | | |
Discover Financial Services | $ | 14,339 | | | 14.8 | % | | $ | 4,373 | | | ≥4.5% | | N/A | | N/A |
Discover Bank | $ | 13,932 | | | 14.7 | % | | $ | 4,260 | | | ≥4.5% | | $ | 6,153 | | | ≥6.5% |
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December 31, 2020 | | | | | | | | | | | |
Total capital (to risk-weighted assets) | | | | | | | | | | | |
Discover Financial Services | $ | 14,711 | | | 16.1 | % | | $ | 7,298 | | | ≥8.0% | | $ | 9,123 | | | ≥10.0% |
Discover Bank | $ | 14,507 | | | 16.1 | % | | $ | 7,214 | | | ≥8.0% | | $ | 9,018 | | | ≥10.0% |
Tier 1 capital (to risk-weighted assets) | | | | | | | | | | | |
Discover Financial Services | $ | 13,006 | | | 14.3 | % | | $ | 5,474 | | | ≥6.0% | | $ | 5,474 | | | ≥6.0% |
Discover Bank | $ | 12,415 | | | 13.8 | % | | $ | 5,411 | | | ≥6.0% | | $ | 7,214 | | | ≥8.0% |
Tier 1 capital (to average assets) | | | | | | | | | | | |
Discover Financial Services | $ | 13,006 | | | 10.9 | % | | $ | 4,757 | | | ≥4.0% | | N/A | | N/A |
Discover Bank | $ | 12,415 | | | 10.5 | % | | $ | 4,709 | | | ≥4.0% | | $ | 5,886 | | | ≥5.0% |
Common Equity Tier 1 (to risk-weighted assets) | | | | | | | | | | | |
Discover Financial Services | $ | 11,950 | | | 13.1 | % | | $ | 4,105 | | | ≥4.5% | | N/A | | N/A |
Discover Bank | $ | 12,415 | | | 13.8 | % | | $ | 4,058 | | | ≥4.5% | | $ | 5,862 | | | ≥6.5% |
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(1)Capital ratios are calculated based on the Basel III standardized approach rules, subject to applicable transition provisions, including CECL transition provisions.
(2)The Basel III rules do not establish well-capitalized thresholds for these measures for bank holding companies. Existing well-capitalized thresholds established in the Federal Reserve’s Regulation Y have been included where available.
The amount of dividends that a bank may pay in any year is subject to certain regulatory restrictions. Under the current banking regulations, a bank may not pay dividends if such a payment would leave the bank inadequately capitalized. Discover Bank paid dividends of $3.3 billion, $555 million and $2.5 billion in the years ended December 31, 2021, 2020 and 2019, respectively, to DFS.
18. Commitments, Contingencies and Guarantees
In the normal course of business, the Company enters into a number of off-balance sheet commitments, transactions and obligations under guarantee arrangements that expose the Company to varying degrees of risk. The Company’s commitments, contingencies and guarantee relationships are described below.
Commitments
Unused Credit Arrangements
At December 31, 2021, the Company had unused credit arrangements for loans of approximately $220.7 billion. Such arrangements arise primarily from agreements with customers for unused lines of credit on certain credit cards and certain other loan products, provided there is no violation of conditions in the related agreements. These arrangements, substantially all of which the Company can terminate at any time and which do not necessarily represent future cash requirements, are periodically reviewed based on account usage, customer creditworthiness and loan qualification. As the Company’s credit card loans are unconditionally cancellable, no liability for expected credit losses is required for unused lines of credit. For all other loans, the Company records a liability for expected credit losses for unfunded commitments, which is presented as part of accrued expenses and other liabilities in the consolidated statements of financial condition.
Contingencies
See Note 19: Litigation and Regulatory Matters for a description of potential liability arising from pending litigation or regulatory proceedings involving the Company.
Guarantees
The Company has obligations under certain guarantee arrangements, including contracts, indemnification agreements and representations and warranties, which contingently require the Company to make payments to the guaranteed party based on changes in an underlying asset, liability or equity security of a guaranteed party, rate or index. Also included as guarantees are contracts that contingently require the Company to make payments to a guaranteed party based on another entity’s failure to perform under an agreement. The Company’s use of guarantees is disclosed below by type of guarantee.
Securitizations Representations and Warranties
As part of the Company’s financing activities, the Company provides representations and warranties that certain assets pledged as collateral in secured borrowing arrangements conform to specified guidelines. Due diligence is performed by the Company, which is intended to ensure that asset guideline qualifications are met. If the assets pledged as collateral do not meet certain conforming guidelines, the Company may be required to replace, repurchase or sell such assets. In its credit card securitization activities, the Company would replace nonconforming receivables through the allocation of excess seller’s interest or from additional transfers from the unrestricted pool of receivables. If the Company could not add enough receivables to satisfy the requirement, an early amortization (or repayment) of investors’ interests would be triggered. In its student loan securitizations, the Company would generally repurchase the loans from the trust at the outstanding principal amount plus interest.
The maximum potential amount of future payments the Company could be required to make would be equal to the current outstanding balances of third-party investor interests in credit card asset-backed securities and the principal amount of any student loan secured borrowings, plus any unpaid interest for the corresponding secured borrowings. The Company has recorded substantially all of the maximum potential amount of future payments in long-term borrowings on the Company’s consolidated statements of financial condition. The Company has not recorded any incremental contingent liability associated with its secured borrowing representations and warranties. Management believes that the probability of having to replace, repurchase or sell assets pledged as collateral under secured borrowing arrangements, including an early amortization event, is low.
Counterparty Settlement Guarantees
Diners Club and DFS Services LLC (on behalf of PULSE) have various counterparty exposures, which are listed below:
•Merchant Guarantee. Diners Club has entered into contractual relationships with certain international merchants, which generally include travel-related businesses, for the benefit of all Diners Club licensees. The licensees hold the primary liability to settle the transactions of their customers with these merchants. However, Diners Club retains a counterparty exposure if a licensee fails to meet its financial payment obligation to one of these merchants.
•ATM Guarantee. PULSE entered into contractual relationships with certain international ATM acquirers in which DFS Services LLC retains counterparty exposure if an issuer fails to fulfill its settlement obligation.
•Global Network Alliance Guarantee. Discover Network, Diners Club and PULSE have entered into contractual relationships with certain international payment networks in which DFS Services LLC retains the counterparty exposure if a network fails to fulfill its settlement obligation.
The maximum potential amount of future payments related to such contingent obligations is dependent upon the transaction volume processed between the time a potential counterparty defaults on its settlement and the time at which the Company disables the settlement of any further transactions for the defaulting party. The Company has some contractual remedies to offset these counterparty settlement exposures (such as letters of credit or pledged deposits), however, there is no limitation on the maximum amount the Company may be liable to pay.
The actual amount of the potential exposure cannot be quantified as the Company cannot determine whether particular counterparties will fail to meet their settlement obligations. In the event that all licensees and/or issuers were to become unable to settle their transactions, the Company estimates its maximum potential counterparty exposures to these settlement guarantees would be approximately $70 million as of December 31, 2021.
The Company believes that the estimated amounts of maximum potential future payments are not representative of the Company’s actual potential loss exposure given Diners Club’s and PULSE’s insignificant historical losses from these counterparty exposures. As of December 31, 2021, the Company had not recorded any contingent liability in the consolidated financial statements for these counterparty exposures and management believes that the probability of any payments under these arrangements is low.
Discover Network Merchant Chargeback Guarantees
The Company operates the Discover Network, issues payment cards and permits third parties to issue payment cards. The Company is contingently liable for certain transactions processed on the Discover Network in the event of a dispute between the payment card customer and a merchant. The contingent liability arises if the disputed transaction involves a merchant or merchant acquirer with whom the Discover Network has a direct relationship. If a dispute is resolved in the customer’s favor, the Discover Network will credit or refund the disputed amount to the Discover Network card issuer, who in turn credits its customer’s account. The Discover Network will then charge back the disputed amount of the payment card transaction to the merchant or merchant acquirer, where permitted by the applicable agreement, to seek recovery of amounts already paid to the merchant for payment card transactions. If the Discover Network is unable to collect the amount subject to dispute from the merchant or merchant acquirer (e.g., in the event of merchant default or dissolution or after expiration of the time period for chargebacks in the applicable agreement), the Discover Network will bear the loss for the amount credited or refunded to the customer. In most instances, a loss by the Discover Network is unlikely to arise in connection with payments on card transactions because most products or services are delivered when purchased and credits are issued by merchants on returned items in a timely fashion, thus minimizing the likelihood of cardholder disputes with respect to amounts paid by the Discover Network. However, where the product or service is not scheduled to be provided to the customer until a later date following the purchase, the likelihood of a contingent payment obligation by the Discover Network increases. Losses related to merchant chargebacks were not material for the years ended December 31, 2021, 2020 and 2019.
The maximum potential amount of obligations of the Discover Network arising as a result of such contingent obligations is estimated to be the portion of the total Discover Network transaction volume processed to date for which timely and valid disputes may be raised under applicable law and relevant issuer and customer agreements. There is no limitation on the maximum amount the Company may be liable to pay to issuers. However, the Company believes that such amount is not representative of the Company’s actual potential loss exposure based on the Company’s historical
experience. The actual amount of the potential exposure cannot be quantified as the Company cannot determine whether the current or cumulative transaction volumes may include or result in disputed transactions.
The following table summarizes certain information regarding merchant chargeback guarantees (dollars in millions): | | | | | | | | | | | | | | | | | |
| For the Years Ended December 31, |
| 2021 | | 2020 | | 2019 |
Aggregate sales transaction volume(1) | $ | 223,360 | | | $ | 175,026 | | | $ | 172,463 | |
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(1)Represents transactions processed on the Discover Network for which a potential liability exists that, in aggregate, can differ from credit card sales volume.
The Company did not record any contingent liability in the consolidated financial statements for merchant chargeback guarantees as of December 31, 2021 or 2020. The Company mitigates the risk of potential loss exposure by withholding settlement from merchants, obtaining third-party guarantees, or obtaining escrow deposits or letters of credit from certain merchant acquirers or merchants that are considered higher risk due to various factors such as time delays in the delivery of products or services. As of December 31, 2021 and 2020, the Company had escrow deposits and settlement withholdings of $15 million and $16 million, respectively, which are recorded in interest-bearing deposit accounts and accrued expenses and other liabilities on the Company’s consolidated statements of financial condition.
19. Litigation and Regulatory Matters
In the normal course of business, from time to time, the Company has been named as a defendant in various legal actions, including arbitrations, class actions and other litigation, arising in connection with its activities. Certain of the actual or threatened legal actions include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages. The litigation process is not predictable and can lead to unexpected results. The Company contests liability and/or the amount of damages as appropriate in each pending matter.
The Company has historically offered its customers an arbitration clause in its customer agreements. The arbitration clause allows the Company and its customers to quickly and economically resolve disputes. Additionally, the arbitration clause has in some instances limited the costs of, and the Company’s exposure to, litigation. Future legal and regulatory challenges and prohibitions may cause the Company to discontinue its offering and use of such clauses. From time to time, the Company is involved in legal actions challenging its arbitration clause. Bills may be periodically introduced in Congress to directly or indirectly prohibit the use of pre-dispute arbitration clauses.
The Company is also involved, from time to time, in other reviews, investigations and proceedings (both formal and informal) by governmental agencies regarding the Company’s business including, among other matters, consumer regulatory, accounting, tax and other operational matters. The investigations and proceedings may result in significant adverse judgments, settlements, fines, penalties, injunctions, decreases in regulatory ratings, customer restitution or other relief. These outcomes could materially impact the Company’s consolidated financial statements, increase its cost of operations, or limit the Company’s ability to execute its business strategies and engage in certain business activities. Certain subsidiaries of the Company are subject to a consent order with the Consumer Financial Protection Bureau (“CFPB”) regarding certain private student loan servicing practices, as described below. Pursuant to powers granted under federal banking laws, regulatory agencies have broad and sweeping discretion and may assess civil money penalties, require changes to certain business practices or require customer restitution at any time.
In accordance with applicable accounting guidance, the Company establishes an accrued liability for legal and regulatory matters when those matters present loss contingencies that are both probable and estimable. Litigation and regulatory settlement-related expense was $59 million for the year ended December 31, 2021, $31 million for the year ended December 31, 2020 and immaterial for the year ended December 31, 2019.
There may be an exposure to loss in excess of any amounts accrued. The Company believes the estimate of the aggregate range of reasonably possible losses (meaning the likelihood of losses is more than remote but less than likely), in excess of the amounts that the Company has accrued for legal and regulatory proceedings, is up to $230 million as of December 31, 2021. This estimated range of reasonably possible losses is based on currently available information for those proceedings in which the Company is involved and considers the Company’s best estimate of such losses for those matters for which an estimate can be made. It does not represent the Company’s maximum potential loss exposure. Various aspects of the legal proceedings underlying the estimated range will change from time to time and actual results may vary significantly from the estimate.
The Company’s estimated range noted above involves significant judgment, given the varying stages of the proceedings, the existence of numerous yet to be resolved issues, the breadth of the claims (often spanning multiple years and, in some cases, a wide range of business activities), unspecified damages and/or the novelty of the legal issues presented. The outcome of pending matters could adversely affect the Company’s reputation and be material to the Company’s consolidated financial condition, operating results and cash flows for a particular future period, depending on, among other things, the level of the Company’s income for such period.
In July 2015, the Company announced that its subsidiaries Discover Bank, The Student Loan Corporation and Discover Products Inc. (the “Discover Subsidiaries”), agreed to a consent order with the CFPB with respect to certain private student loan servicing practices (the “2015 Order”). The 2015 Order expired in July 2020. On December 22, 2020, the Discover Subsidiaries agreed to a consent order (the “2020 Order”) with the CFPB resolving the agency’s investigation into Discover Bank’s compliance with the 2015 Order. In connection with the 2020 Order, Discover is required to implement a redress and compliance plan and must pay at least $10 million in consumer redress to consumers who may have been harmed and paid a $25 million civil money penalty to the CFPB.
On March 8, 2016, a class-action lawsuit was filed against the Company, other credit card networks, other issuing banks and EMVCo in the U.S. District Court for the Northern District of California (B&R Supermarket, Inc., d/b/a Milam’s Market, et al. v. Visa, Inc. et al.) alleging a conspiracy by the defendants to shift fraud liability to merchants with the migration to the EMV security standard and chip technology. The plaintiffs assert joint and several liability among the defendants and seek unspecified damages, including treble damages, attorneys’ fees, costs and injunctive relief. In May 2017, the Court entered an order transferring the entire action to a federal court in New York that is presiding over certain related claims that are pending in the actions consolidated as MDL 1720. On August 28, 2020, the Court granted the plaintiffs’ Motion to Certify a Class. The defendants appealed the ruling, which was denied on January 20, 2021. The Company filed a Motion to Compel Arbitration on which briefing closed in March 2021. On September 27, 2021, the court ruled the motion was premature and stated it would not issue a ruling until after the issuance of class notices. The court set the deadline for expert discovery on February 28, 2022. The Company is not in a position at this time to assess the likely outcome or its exposure, if any, with respect to this matter. However, the Company will seek to defend itself vigorously against all claims asserted by the plaintiffs.
20. Fair Value Measurements
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820, Fair Value Measurement, provides a three-level hierarchy for classifying financial instruments based on whether the inputs to the valuation techniques are observable or unobservable. It also requires certain disclosures about those measurements. The three-level valuation hierarchy is as follows:
•Level 1: Fair values determined by Level 1 inputs are defined as those that utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access.
•Level 2: Fair values determined by Level 2 inputs are those that utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active or inactive markets, quoted prices for the identical assets in an inactive market and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. The Company evaluates factors such as the frequency of transactions, the size of the bid-ask spread and the significance of adjustments made when considering transactions involving similar assets or liabilities to assess the relevance of those observed prices. If relevant and observable prices are available, the fair values of the related assets or liabilities would be classified as Level 2.
•Level 3: Fair values determined by Level 3 inputs are those based on unobservable inputs and include situations where there is little, if any, market activity for the asset or liability being valued. In instances where the inputs used to measure fair value may fall into different levels of the fair value hierarchy, the level in the fair value hierarchy in which the measurements are classified is based on the lowest level input that is significant to the fair value measurement in its entirety. Accordingly, the Company may utilize both observable and unobservable inputs in determining the fair values of financial instruments classified within the Level 3 category.
The Company evaluates the classification of each fair value measurement within the hierarchy at least quarterly.
The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and involves consideration of factors specific to the asset or liability. Furthermore, certain techniques used to measure fair value involve some degree of judgment and, as a result, are not necessarily indicative of the amounts the Company would realize in a current market exchange.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
Assets and liabilities measured at fair value on a recurring basis are as follows (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | |
| Quoted Price in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) | | Total |
Balance at December 31, 2021 | | | | | | | |
Assets | | | | | | | |
Fair value - OCI | | | | | | | |
U.S. Treasury and U.S. GSE securities | $ | 6,505 | | | $ | 9 | | | $ | — | | | $ | 6,514 | |
Residential mortgage-backed securities - Agency | — | | | 186 | | | — | | | 186 | |
Available-for-sale investment securities | $ | 6,505 | | | $ | 195 | | | $ | — | | | $ | 6,700 | |
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Fair value - Net income | | | | | | | |
Marketable equity securities | $ | 461 | | | $ | — | | | $ | — | | | $ | 461 | |
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Balance at December 31, 2020 | | | | | | | |
Assets | | | | | | | |
Fair value - OCI | | | | | | | |
U.S. Treasury securities | $ | 9,354 | | | $ | — | | | $ | — | | | $ | 9,354 | |
Residential mortgage-backed securities - Agency | — | | | 300 | | | — | | | 300 | |
Available-for-sale investment securities | $ | 9,354 | | | $ | 300 | | | $ | — | | | $ | 9,654 | |
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Fair value - Net income | | | | | | | |
Derivative financial instruments - fair value hedges(1) | $ | — | | | $ | 1 | | | $ | — | | | $ | 1 | |
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(1)Derivative instrument carrying values in an asset or liability position are presented as part of other assets or accrued expenses and other liabilities, respectively, in the Company’s consolidated statements of financial condition.
Available-for-Sale Investment Securities
Investment securities classified as available-for-sale consist of U.S. Treasury and U.S. GSE securities and RMBS. The fair value estimates of investment securities classified as Level 1, consisting of U.S. Treasury securities, are determined based on quoted market prices for the same securities. The fair value estimates of U.S. GSE securities and RMBS are classified as Level 2 and are valued by maximizing the use of relevant observable inputs, including quoted prices for similar securities, benchmark yield curves and market-corroborated inputs.
The Company validates the fair value estimates provided by pricing services primarily by comparing to valuations obtained through other pricing sources. The Company evaluates pricing variances among different pricing sources to ensure that the valuations utilized are reasonable. The Company also corroborates the reasonableness of the fair value estimates with analysis of trends of significant inputs, such as market interest rate curves. The Company further performs due diligence in understanding the procedures and techniques performed by the pricing services to derive fair value estimates.
At December 31, 2021, amounts reported in RMBS reflect U.S. government agency and U.S. GSE obligations issued by Ginnie Mae, Fannie Mae and Freddie Mac with an aggregate par value of $179 million, a weighted-average coupon of 3.24% and a weighted-average remaining maturity of two years.
Marketable Equity Securities
The Company holds non-controlling equity positions in payment service entities that have actively traded stock and therefore have readily determinable fair values. The Company classifies these equity securities as Level 1, the fair value estimates of which are determined based on quoted share prices for the same securities.
Derivative Financial Instruments
The Company’s derivative financial instruments consist of interest rate swaps and foreign exchange forward contracts. These instruments are classified as Level 2 as their fair values are estimated using proprietary pricing models, containing certain assumptions based on readily observable market-based inputs, including interest rate curves, option volatility and foreign currency forward and spot rates. In determining fair values, the pricing models use widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity and the observable market-based inputs. The fair values of the interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments are based on an expectation of future interest rates derived from the observable market interest rate curves. The Company considers collateral and master netting agreements that mitigate credit exposure to counterparties in determining the counterparty credit risk valuation adjustment. The fair values of the currency instruments are valued comparing the contracted forward exchange rate pertaining to the specific contract maturities to the current market exchange rate.
The Company validates the fair value estimates of interest rate swaps primarily through comparison to the fair value estimates computed by the counterparties to each of the derivative transactions. The Company evaluates pricing variances among different pricing sources to ensure that the valuations utilized are reasonable. The Company also corroborates the reasonableness of the fair value estimates with analysis of trends of significant inputs, such as market interest rate curves. The Company performs due diligence in understanding the impact of any changes to the valuation techniques performed by proprietary pricing models before implementation, working closely with the third-party valuation service and reviewing the service’s control objectives at least annually. The Company corroborates the fair value of foreign exchange forward contracts through independent calculation of the fair value estimates.
As of October 16, 2020, the Company revised its valuation methodology to reflect changes made by central clearinghouses that changed the discounting methodology and interest calculation of cash variation margin from Federal Funds OIS to the Secured Overnight Financing Rate (“SOFR”) OIS for U.S. Dollar cleared interest rate swaps. The Company’s valuation methodology will result in valuations for cleared interest rate swaps that better reflect cleared swap prices obtainable in the markets in which the Company transacts. Pursuant to ASC Topic 848, the Company has elected and applied certain optional expedients and exceptions that provide contract modification and hedge accounting relief to eligible interest rate swaps affected by the change in the discounting methodology. The changes in valuation methodology are applied prospectively as a change in accounting estimate and are immaterial to the Company’s financial statements.
Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis
The Company also has assets that under certain conditions are subject to measurement at fair value on a non-recurring basis. These assets include those associated with acquired businesses, including goodwill and other intangible assets. For these assets, measurement at fair value in periods subsequent to the initial recognition of the assets may be applicable whenever one is tested for impairment. The Company recognized $95 million and $59 million of impairments related to these assets for the years ended December 31, 2021 and 2020, respectively. See Note 7: Goodwill and Intangible Assets for more information on the impact of the COVID-19 pandemic on intangible assets.
Financial Instruments Measured at Other Than Fair Value
The following tables disclose the estimated fair value of the Company’s financial assets and financial liabilities that are not required to be carried at fair value (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balance at December 31, 2021 | Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) | | Total | | Carrying Value |
Assets | | | | | | | | | |
Amortized cost | | | | | | | | | |
Residential mortgage-backed securities - Agency | $ | — | | | $ | 206 | | | $ | — | | | $ | 206 | | | $ | 204 | |
Held-to-maturity investment securities | $ | — | | | $ | 206 | | | $ | — | | | $ | 206 | | | $ | 204 | |
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Net loan receivables | $ | — | | | $ | — | | | $ | 94,176 | | | $ | 94,176 | | | $ | 86,862 | |
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Carrying value approximates fair value(1) | | | | | | | | | |
Cash and cash equivalents | $ | 8,750 | | | $ | — | | | $ | — | | | $ | 8,750 | | | $ | 8,750 | |
Restricted cash | $ | 2,582 | | | $ | — | | | $ | — | | | $ | 2,582 | | | $ | 2,582 | |
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Accrued interest receivables(2) | $ | — | | | $ | 948 | | | $ | — | | | $ | 948 | | | $ | 948 | |
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Amortized cost | | | | | | | | | |
Time deposits(3) | $ | — | | | $ | 21,490 | | | $ | — | | | $ | 21,490 | | | $ | 21,125 | |
Short-term borrowings | $ | — | | | $ | 1,750 | | | $ | — | | | $ | 1,750 | | | $ | 1,750 | |
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Long-term borrowings - owed to securitization investors | $ | — | | | $ | 8,953 | | | $ | 104 | | | $ | 9,057 | | | $ | 9,039 | |
Other long-term borrowings | — | | | 10,013 | | | — | | | 10,013 | | | 9,438 | |
Long-term borrowings | $ | — | | | $ | 18,966 | | | $ | 104 | | | $ | 19,070 | | | $ | 18,477 | |
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Carrying value approximates fair value(1) | | | | | | | | | |
Accrued interest payables(2) | $ | — | | | $ | 184 | | | $ | — | | | $ | 184 | | | $ | 184 | |
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Balance at December 31, 2020 | Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) | | Total | | Carrying Value |
Assets | | | | | | | | | |
Amortized cost | | | | | | | | | |
Residential mortgage-backed securities - Agency | $ | — | | | $ | 269 | | | $ | — | | | $ | 269 | | | $ | 260 | |
Held-to-maturity investment securities | $ | — | | | $ | 269 | | | $ | — | | | $ | 269 | | | $ | 260 | |
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Net loan receivables | $ | — | | | $ | — | | | $ | 91,200 | | | $ | 91,200 | | | $ | 82,223 | |
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Carrying value approximates fair value(1) | | | | | | | | | |
Cash and cash equivalents | $ | 13,564 | | | $ | — | | | $ | — | | | $ | 13,564 | | | $ | 13,564 | |
Restricted cash | $ | 25 | | | $ | — | | | $ | — | | | $ | 25 | | | $ | 25 | |
Other short-term investments | $ | 2,200 | | | $ | — | | | $ | — | | | $ | 2,200 | | | $ | 2,200 | |
Accrued interest receivables(2) | $ | — | | | $ | 992 | | | $ | — | | | $ | 992 | | | $ | 992 | |
| | | | | | | | | |
Liabilities | | | | | | | | | |
Amortized cost | | | | | | | | | |
Time deposits(3) | $ | — | | | $ | 29,090 | | | $ | — | | | $ | 29,090 | | | $ | 28,269 | |
| | | | | | | | | |
| | | | | | | | | |
Long-term borrowings - owed to securitization investors | $ | — | | | $ | 10,794 | | | $ | 130 | | | $ | 10,924 | | | $ | 10,840 | |
Other long-term borrowings | — | | | 11,418 | | | — | | | 11,418 | | | 10,401 | |
Long-term borrowings | $ | — | | | $ | 22,212 | | | $ | 130 | | | $ | 22,342 | | | $ | 21,241 | |
| | | | | | | | | |
Carrying value approximates fair value(1) | | | | | | | | | |
Accrued interest payables(2) | $ | — | | | $ | 233 | | | $ | — | | | $ | 233 | | | $ | 233 | |
| | | | | | | | | |
(1) The carrying values of these assets and liabilities approximate fair value due to their short-term nature.
(2) Accrued interest receivable and payable carrying values are presented as part of other assets or accrued expenses and other liabilities, respectively, in the Company’s consolidated statements of financial condition.
(3) Excludes deposits without contractually defined maturities for all periods presented.
21. Derivatives and Hedging Activities
The Company uses derivatives to manage its exposure to various financial risks. The Company does not enter into derivatives for trading or speculative purposes. Certain derivatives used to manage the Company’s exposure to foreign currency are not designated as hedges and do not qualify for hedge accounting.
Derivatives may give rise to counterparty credit risk, which generally is mitigated through collateral arrangements as described under the sub-heading “— Collateral Requirements and Credit-Risk Related Contingency Features.” The Company enters into derivative transactions with established dealers that meet minimum credit criteria established by the Company. All counterparties must be pre-approved before engaging in any transaction with the Company. The Company regularly monitors counterparties to ensure compliance with the Company’s risk policies and limits. In determining the counterparty credit risk valuation adjustment for the fair values of derivatives, if any, the Company considers collateral and legally enforceable master netting agreements that mitigate credit exposure to related counterparties.
All derivatives are recorded in other assets at their gross positive fair values and in accrued expenses and other liabilities at their gross negative fair values. See Note 20: Fair Value Measurements for a description of the valuation methodologies used for derivatives. Cash collateral amounts associated with derivative positions that are cleared through an exchange are legally characterized as settlement of the derivative positions. Such collateral amounts are reflected as offsets to the associated derivatives balances recorded in other assets or in accrued expenses and other liabilities. Other cash collateral posted and held balances are recorded in other assets and deposits, respectively, in the
consolidated statements of financial condition. Collateral amounts recorded in the consolidated statements of financial condition are based on the net collateral posted or held position for each applicable legal entity’s master netting arrangement with each counterparty.
Derivatives Designated as Hedges
Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows arising from changes in interest rates, or other types of forecasted transactions, are considered cash flow hedges. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges.
Cash Flow Hedges
The Company uses interest rate swaps to manage its exposure to variability in cash flows related to changes in interest rates on interest-earning assets and funding instruments. These interest rate swaps qualify for hedge accounting in accordance with ASC Topic 815, Derivatives and Hedging (“ASC 815”). As of December 31, 2021 and 2020, the Company’s outstanding cash flow hedges related only to interest receipts from credit card receivables and had an initial maximum period of two years.
The change in the fair value of derivatives designated as cash flow hedges is recorded in OCI and is subsequently reclassified into earnings in the period that the hedged forecasted cash flows affect earnings. Amounts reported in AOCI related to derivatives at December 31, 2021, will be reclassified to interest income as interest receipts are accrued on the Company’s then outstanding credit card receivables. During the next 12 months, the Company estimates it will reclassify $3 million of pretax earnings primarily related to one terminated derivative formerly designated as a cash flow hedge.
Fair Value Hedges
The Company is exposed to changes in the fair value of its fixed-rate debt obligations due to changes in interest rates. The Company uses interest rate swaps to manage its exposure to changes in fair value of certain fixed-rate long-term borrowings, including securitized debt and bank notes, attributable to changes in LIBOR or Federal Funds OIS rate, which are benchmark interest rates defined by ASC 815. These interest rate swaps qualify as fair value hedges in accordance with ASC 815. Changes in the fair values of both (i) the derivatives and (ii) the hedged long-term borrowings attributable to the interest rate risk being hedged are recorded in interest expense. The changes generally provide substantial offset to one another, with any difference recognized in interest expense.
Derivatives Not Designated as Hedges
Foreign Exchange Forward Contracts
The Company has foreign exchange forward contracts that are economic hedges and are not designated as accounting hedges. The Company enters into foreign exchange forward contracts to manage foreign currency risk. Changes in the fair value of these contracts are recorded in other income.
Derivatives Cleared Through an Exchange
Cash variation margin payments on derivatives cleared through an exchange are legally considered settlement payments and are accounted for with corresponding derivative positions as one unit of account and not presented separately as collateral. With settlement payments on derivative positions cleared through this exchange reflected as offsets to the associated derivative asset and liability balances, the fair values of derivative instruments and collateral balances shown are generally reduced.
Derivatives Activity
The following table summarizes the fair value (including accrued interest) and outstanding notional amounts of derivative instruments and related collateral balances (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, |
| 2021 | | 2020 |
| Notional Amount | | Number of Outstanding Derivative Contracts | | Derivative Assets | | Derivative Liabilities | | Notional Amount | | Derivative Assets | | Derivative Liabilities |
Derivatives designated as hedges | | | | | | | | | | | | | |
Interest rate swaps — cash flow hedge | $ | 250 | | | 1 | | | $ | — | | | $ | — | | | $ | 250 | | | $ | — | | | $ | — | |
Interest rate swaps — fair value hedge | $ | 6,125 | | | 7 | | | — | | | — | | | $ | 11,625 | | | 1 | | | — | |
Derivatives not designated as hedges | | | | | | | | | | | | | |
Foreign exchange forward contracts(1) | $ | 36 | | | 7 | | | — | | | — | | | $ | 24 | | | — | | | — | |
Total gross derivative assets/liabilities(2) | | | | | — | | | — | | | | | 1 | | | — | |
| | | | | | | | | | | | | |
Less: collateral held/posted(3) | | | | | — | | | — | | | | | — | | | — | |
Total net derivative assets/liabilities | | | | | $ | — | | | $ | — | | | | | $ | 1 | | | $ | — | |
| | | | | | | | | | | | | |
(1)The foreign exchange forward contracts have notional amounts of EUR 6 million, GBP 6 million, SGD 1 million, INR 788 million and AUD 14 million as of December 31, 2021, and notional amounts of EUR 6 million, GBP 6 million, SGD 1 million and INR 596 million as of December 31, 2020.
(2)In addition to the derivatives disclosed in the table, the Company enters into forward contracts to purchase when-issued mortgage-backed securities as part of its community reinvestment initiatives. At December 31, 2021, the Company had one outstanding contract with a total notional amount of $50 million and an immaterial fair value. At December 31, 2020, the Company had one outstanding contract with a total notional amount of $27 million and an immaterial fair value.
(3)Collateral amounts, which consist of cash and investment securities, are limited to the related derivative asset/liability balance and do not include excess collateral received/pledged.
The following amounts were recorded on the statements of financial condition related to cumulative basis adjustments for fair value hedges (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, |
| 2021 | | 2020 |
| Carrying Amount of Hedged Liabilities | | Cumulative Amount of Fair Value Hedging Adjustment Increasing (Decreasing) the Carrying Amount of Hedged Liabilities | | Carrying Amount of Hedged Liabilities | | Cumulative Amount of Fair Value Hedging Adjustment Increasing the Carrying Amount of Hedged Liabilities |
Long-term borrowings | $ | 6,158 | | | $ | (83) | | | $ | 11,881 | | | $ | 281 | |
| | | | | | | |
The following table summarizes the impact of the derivative instruments on income and indicates where within the consolidated financial statements such impact is reported (dollars in millions): | | | | | | | | | | | | | | | | | |
| Location and Amount of (Losses) Gains Recognized on the Condensed Consolidated Statements of Income |
| Interest Expense | | Other Income |
| Deposits | | Long-Term Borrowings | |
For the Year Ended December 31, 2021 | | | | | |
Total amounts of income and expense line items presented in the consolidated statements of income, where the effects of fair value or cash flow hedges are recorded | $ | (661) | | | $ | (473) | | | $ | 66 | |
| | | | | |
The effects of cash flow and fair value hedging | | | | | |
Gains (Losses) on cash flow hedging relationship | | | | | |
Amounts reclassified from OCI into earnings | $ | — | | | $ | (3) | | | $ | — | |
| | | | | |
Gains (losses) on fair value hedging relationships | | | | | |
Gains (losses) on hedged items | $ | — | | | $ | 246 | | | $ | — | |
Gains (losses) on interest rate swaps | — | | | (93) | | | — | |
Total gains on fair value hedging relationships | $ | — | | | $ | 153 | | | $ | — | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
For the Year Ended December 31, 2020 | | | | | |
Total amounts of income and expense line items presented in the consolidated statements of income, where the effects of fair value or cash flow hedges are recorded | $ | (1,231) | | | $ | (602) | | | $ | 56 | |
| | | | | |
The effects of cash flow and fair value hedging | | | | | |
Losses on cash flow hedging relationship | | | | | |
Amounts reclassified from OCI into earnings | $ | (9) | | | $ | (3) | | | $ | — | |
| | | | | |
Gains (losses) on fair value hedging relationships | | | | | |
Gains (losses) on hedged items | $ | — | | | $ | (268) | | | $ | — | |
Gains on interest rate swaps | — | | | 423 | | | — | |
Total gains on fair value hedging relationships | $ | — | | | $ | 155 | | | $ | — | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| |
| | | |
| | | | | |
For the Year Ended December 31, 2019 | | | | | |
Total amounts of income and expense line items presented in the consolidated statements of income, where the effects of fair value or cash flow hedges are recorded | $ | (1,587) | | | $ | (943) | | | $ | 93 | |
| | | | | |
The effects of cash flow and fair value hedging | | | | | |
Gains on cash flow hedging relationship | | | | | |
Amounts reclassified from OCI into earnings | $ | 3 | | | $ | 2 | | | $ | — | |
| | | | | |
Gains (losses) on fair value hedging relationship | | | | | |
Gains (losses) on hedged items | $ | — | | | $ | (104) | | | $ | — | |
Gains on interest rate swaps | — | | | 72 | | | — | |
Total gains (losses) on fair value hedging relationship | $ | — | | | $ | (32) | | | $ | — | |
| | | | | |
The effects of derivatives not designated in hedging relationships | | | | | |
Gains (losses) on derivatives not designated as hedges | $ | — | | | $ | — | | | $ | (1) | |
| | | | | |
For the impact of the derivative instruments on OCI, see Note 13: Accumulated Other Comprehensive Income.
Collateral Requirements and Credit-Risk Related Contingency Features
The Company has master netting arrangements and minimum collateral posting thresholds with its counterparties for its fair value and cash flow hedge interest rate swaps and foreign exchange forward contracts. The Company has not sought a legal opinion in relation to the enforceability of its master netting arrangements and, as such, does not report any of these positions on a net basis. Collateral is required by either the Company or its subsidiaries or the counterparty depending on the net fair value position of the derivatives held with that counterparty. These collateral receivable or payable amounts are generally not offset against the fair value of these derivatives but are recorded separately in other assets or deposits. Most of the Company’s cash collateral amounts relate to positions cleared through an exchange and are reflected as offsets to the associated derivatives balances recorded in other assets and accrued expenses and other liabilities.
The Company also has agreements with certain of its derivative counterparties that contain a provision under which the Company could be declared in default on any of its derivative obligations if the Company defaults on any of its indebtedness, including default where the lender has not accelerated repayment of the indebtedness.
22. Segment Disclosures
The Company manages its business activities in two segments: Digital Banking and Payment Services.
•Digital Banking: The Digital Banking segment includes Discover-branded credit cards issued to individuals on the Discover Network and other consumer products and services, including private student loans, personal loans, home loans and other consumer lending and deposit products. The majority of Digital Banking revenues relate to interest income earned on the segment’s loan products. Additionally, the Company’s credit card products generate substantially all revenues related to discount and interchange, protection products and loan fee income.
•Payment Services: The Payment Services segment includes PULSE, an automated teller machine, debit and electronic funds transfer network; Diners Club, a global payments network; and the Company’s Network Partners business, which provides payment transaction processing and settlement services on the Discover Network. The majority of Payment Services revenues relate to transaction processing revenue from PULSE and royalty and licensee revenue from Diners Club.
The business segment reporting provided to and used by the Company’s chief operating decision-maker is prepared using the following principles and allocation conventions:
•The Company aggregates operating segments when determining reportable segments.
•Corporate overhead is not allocated between segments; all corporate overhead is included in the Digital Banking segment.
•Through its operation of the Discover Network, the Digital Banking segment incurs fixed marketing, servicing and infrastructure costs that are not specifically allocated among the segments, except for an allocation of direct and incremental costs driven by the Company’s Payment Services segment.
•The Company’s assets are not allocated among the operating segments in the information reviewed by the Company’s chief operating decision-maker.
•The revenues of each segment are derived from external sources. The segments do not earn revenue from intercompany sources.
•Income taxes are not specifically allocated between the operating segments in the information reviewed by the Company’s chief operating decision maker.
The following table presents segment data (dollars in millions): | | | | | | | | | | | | | | | | | |
| Digital Banking | | Payment Services | | Total |
For the Year Ended December 31, 2021 | | | | | |
Interest income | | | | | |
Credit card loans | $ | 8,717 | | | $ | — | | | $ | 8,717 | |
Private student loans | 742 | | | — | | | 742 | |
Personal loans | 878 | | | — | | | 878 | |
Other loans | 114 | | | — | | | 114 | |
Other interest income | 200 | | | — | | | 200 | |
Total interest income | 10,651 | | | — | | | 10,651 | |
Interest expense | 1,134 | | | — | | | 1,134 | |
Net interest income | 9,517 | | | — | | | 9,517 | |
Provision for credit losses | 218 | | | — | | | 218 | |
Other income | 1,781 | | | 789 | | | 2,570 | |
Other expense | 4,549 | | | 256 | | | 4,805 | |
Income before income tax expense | $ | 6,531 | | | $ | 533 | | | $ | 7,064 | |
| | | | | |
For the Year Ended December 31, 2020 | | | | | |
Interest income | | | | | |
Credit card loans | $ | 8,985 | | | $ | — | | | $ | 8,985 | |
Private student loans | 754 | | | — | | | 754 | |
Personal loans | 958 | | | — | | | 958 | |
Other loans | 106 | | | — | | | 106 | |
Other interest income | 292 | | | — | | | 292 | |
Total interest income | 11,095 | | | — | | | 11,095 | |
Interest expense | 1,865 | | | — | | | 1,865 | |
Net interest income | 9,230 | | | — | | | 9,230 | |
Provision for credit losses | 5,134 | | | — | | | 5,134 | |
Other income | 1,459 | | | 399 | | | 1,858 | |
Other expense | 4,292 | | | 227 | | | 4,519 | |
Income before income tax expense | $ | 1,263 | | | $ | 172 | | | $ | 1,435 | |
| | | | | |
| | | | | |
For the Year Ended December 31, 2019 | | | | | |
Interest income | | | | | |
Credit card loans | $ | 9,690 | | | $ | — | | | $ | 9,690 | |
Private student loans | 817 | | | — | | | 817 | |
Personal loans | 983 | | | — | | | 983 | |
Other loans | 70 | | | — | | | 70 | |
Other interest income | 432 | | | 1 | | | 433 | |
Total interest income | 11,992 | | | 1 | | | 11,993 | |
Interest expense | 2,530 | | | — | | | 2,530 | |
Net interest income | 9,462 | | | 1 | | | 9,463 | |
Provision for credit losses(1) | 3,233 | | | (2) | | | 3,231 | |
Other income | 1,648 | | | 348 | | | 1,996 | |
Other expense | 4,231 | | | 162 | | | 4,393 | |
Income before income tax expense | $ | 3,646 | | | $ | 189 | | | $ | 3,835 | |
| | | | | |
(1)Prior to the adoption of ASU No. 2016-13 on January 1, 2020, credit losses were estimated using the incurred loss approach.
23. Revenue from Contracts with Customers
ASC Topic 606, Revenue from Contracts with Customers (“ASC 606”), generally applies to the sales of any good or service for which no other specific accounting guidance is provided. ASC 606 defines a principles-based model under which revenue from a contract is allocated to the distinct performance obligations within the contract and recognized in income as each performance obligation is satisfied. The Company’s revenue that is subject to this model includes discount and interchange, protection products fees, transaction processing revenue and amounts classified as other income.
The following table presents revenue from contracts with customers disaggregated by business segment and reconciles revenue from contracts with customers to total other income (dollars in millions): | | | | | | | | | | | | | | | | | |
| Digital Banking | | Payment Services | | Total |
For the Year Ended December 31, 2021 | | | | | |
Other income subject to ASC 606 | | | | | |
Discount and interchange revenue, net(1) | $ | 1,151 | | | $ | 73 | | | $ | 1,224 | |
Protection products revenue | 165 | | | — | | | 165 | |
Transaction processing revenue | — | | | 227 | | | 227 | |
Other income | — | | | 66 | | | 66 | |
Total other income subject to ASC 606(2) | 1,316 | | | 366 | | | 1,682 | |
Other income not subject to ASC 606 | | | | | |
Loan fee income | 464 | | | — | | | 464 | |
Other income | 1 | | | 423 | | | 424 | |
Total other income not subject to ASC 606 | 465 | | | 423 | | | 888 | |
Total other income by operating segment | $ | 1,781 | | | $ | 789 | | | $ | 2,570 | |
| | | | | |
For the Year Ended December 31, 2020 | | | | | |
Other income subject to ASC 606 | | | | | |
Discount and interchange revenue, net(1) | $ | 871 | | | $ | 62 | | | $ | 933 | |
Protection products revenue | 180 | | | — | | | 180 | |
Transaction processing revenue | — | | | 195 | | | 195 | |
Other (loss) income | (7) | | | 63 | | | 56 | |
Total other income subject to ASC 606(2) | 1,044 | | | 320 | | | 1,364 | |
Other income not subject to ASC 606 | | | | | |
Loan fee income | 414 | | | — | | | 414 | |
Other income | 1 | | | 79 | | | 80 | |
Total other income not subject to ASC 606 | 415 | | | 79 | | | 494 | |
Total other income by operating segment | $ | 1,459 | | | $ | 399 | | | $ | 1,858 | |
| | | | | |
For the Year Ended December 31, 2019 | | | | | |
Other income subject to ASC 606 | | | | | |
Discount and interchange revenue, net(1) | $ | 1,000 | | | $ | 66 | | | $ | 1,066 | |
Protection products revenue | 194 | | | — | | | 194 | |
Transaction processing revenue | — | | | 197 | | | 197 | |
Other income | 8 | | | 85 | | | 93 | |
Total other income subject to ASC 606(2) | 1,202 | | | 348 | | | 1,550 | |
Other income not subject to ASC 606 | | | | | |
Loan fee income | 449 | | | — | | | 449 | |
Other (loss) income | (3) | | | — | | | (3) | |
Total other income not subject to ASC 606 | 446 | | | — | | | 446 | |
Total other income by operating segment | $ | 1,648 | | | $ | 348 | | | $ | 1,996 | |
| | | | | |
(1) Net of rewards, including Cashback Bonus rewards, of $2.5 billion, $1.9 billion and $1.9 billion for the years ended December 31, 2021, 2020 and 2019, respectively.
(2) Excludes $2 million, $2 million and $3 million deposit product fees that are reported within net interest income for the years ended December 31, 2021, 2020 and 2019, respectively.
For a detailed description of the Company’s significant revenue recognition accounting policies, see Note 2: Summary of Significant Accounting Policies.
24. Related Party Transactions
In the ordinary course of business, the Company offers consumer financial products to its directors, executive officers and certain members of their families. These products are offered on substantially the same terms as those prevailing at the time for comparable transactions with unrelated parties and these receivables are included in the loan receivables in the Company’s consolidated statements of financial condition. They were not material to the Company’s financial position or results of operations.
25. Parent Company Condensed Financial Information
The following Parent Company financial statements are provided in accordance with SEC rules, which require such disclosure when the restricted net assets of consolidated subsidiaries exceed 25% of consolidated net assets.
Discover Financial Services
(Parent Company Only)
Condensed Statements of Financial Condition | | | | | | | | | | | |
| December 31, |
| 2021 | | 2020 |
| (dollars in millions) |
Assets | | | |
Cash and cash equivalents(1) | $ | 3,182 | | | $ | 2,802 | |
Restricted cash | 20 | | | 20 | |
Notes receivable from subsidiaries(2) | 777 | | | 891 | |
Investment in bank subsidiary | 11,889 | | | 10,188 | |
Investments in non-bank subsidiaries | 1,209 | | | 727 | |
Other assets | 663 | | | 567 | |
Total assets | $ | 17,740 | | | $ | 15,195 | |
| | | |
Liabilities and Stockholders’ Equity | | | |
Non-interest bearing deposit accounts | $ | 2 | | | $ | 2 | |
| | | |
| | | |
Short-term borrowings from subsidiaries | 439 | | | 283 | |
Long-term borrowings | 3,548 | | | 3,673 | |
Accrued expenses and other liabilities | 343 | | | 353 | |
Total liabilities | 4,332 | | | 4,311 | |
Stockholders’ equity | 13,408 | | | 10,884 | |
Total liabilities and stockholders’ equity | $ | 17,740 | | | $ | 15,195 | |
| | | |
(1)The Parent Company had $3.0 billion and $2.7 billion in a money market deposit account at Discover Bank as of December 31, 2021 and 2020, respectively, which is included in cash and cash equivalents. These funds are available to the Parent for liquidity purposes.
(2)The Parent Company advanced $500 million to Discover Bank as of December 31, 2021 and 2020, which is included in notes receivable from subsidiaries.
Discover Financial Services
(Parent Company Only)
Condensed Statements of Comprehensive Income | | | | | | | | | | | | | | | | | |
| For the Years Ended December 31, |
| 2021 | | 2020 | | 2019 |
| (dollars in millions) |
Interest income | $ | 33 | | | $ | 44 | | | $ | 82 | |
Interest expense | 199 | | | 205 | | | 212 | |
Net interest expense | (166) | | | (161) | | | (130) | |
Dividends from bank subsidiary | 3,250 | | | 555 | | | 2,530 | |
Dividends from non-bank subsidiaries | — | | | 200 | | | 100 | |
Total income | 3,084 | | | 594 | | | 2,500 | |
Other expense | 10 | | | (16) | | | 1 | |
Income before income tax benefit and equity in undistributed net income of subsidiaries | 3,074 | | | 610 | | | 2,499 | |
Income tax benefit | 25 | | | 30 | | | 25 | |
Equity in undistributed net income of subsidiaries | 2,350 | | | 501 | | | 433 | |
Net income | 5,449 | | | 1,141 | | | 2,957 | |
Other comprehensive (loss) income, net | (139) | | | 164 | | | 37 | |
Comprehensive income | $ | 5,310 | | | $ | 1,305 | | | $ | 2,994 | |
| | | | | |
Discover Financial Services
(Parent Company Only)
Condensed Statements of Cash Flows | | | | | | | | | | | | | | | | | |
| For the Years Ended December 31, |
| 2021 | | 2020 | | 2019 |
| (dollars in millions) |
Cash flows provided by operating activities | | | | | |
Net income | $ | 5,449 | | | $ | 1,141 | | | $ | 2,957 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | |
Equity in undistributed net income of subsidiaries | (2,350) | | | (501) | | | (433) | |
Stock-based compensation expense | 103 | | | 42 | | | 69 | |
Deferred income taxes | (13) | | | (5) | | | (8) | |
Depreciation and amortization | 47 | | | 41 | | | 38 | |
Changes in assets and liabilities: | | | | | |
(Increase) decrease in other assets | (91) | | | 42 | | | 92 | |
Increase (decrease) in accrued expenses and other liabilities | 24 | | | (30) | | | 50 | |
Net cash provided by operating activities | 3,169 | | | 730 | | | 2,765 | |
| | | | | |
Cash flows provided by (used for) investing activities | | | | | |
Decrease in investment in subsidiaries | 114 | | | — | | | — | |
Decrease (increase) in loans to subsidiaries | — | | | (15) | | | (55) | |
Net cash provided by (used for) investing activities | 114 | | | (15) | | | (55) | |
| | | | | |
Cash flows used for financing activities | | | | | |
Net increase in short-term borrowings from subsidiaries | 156 | | | — | | | 42 | |
Proceeds from issuance of common stock | 9 | | | 10 | | | 7 | |
Proceeds from issuance of long-term borrowings | — | | | — | | | 595 | |
Maturities and repayment of long-term borrowings | (172) | | | (3) | | | (86) | |
Purchases of treasury stock | (2,260) | | | (348) | | | (1,768) | |
Net increase (decrease) in deposits | — | | | — | | | (2) | |
Proceeds from issuance of preferred stock | — | | | 493 | | | — | |
| | | | | |
Dividends paid on common and preferred stock | (636) | | | (576) | | | (573) | |
Net cash used for financing activities | (2,903) | | | (424) | | | (1,785) | |
Increase in cash, cash equivalents and restricted cash | 380 | | | 291 | | | 925 | |
Cash, cash equivalents and restricted cash, at beginning of period | 2,822 | | | 2,531 | | | 1,606 | |
Cash, cash equivalents and restricted cash, at end of period | $ | 3,202 | | | $ | 2,822 | | | $ | 2,531 | |
| | | | | |
Reconciliation of cash, cash equivalents and restricted cash | | | | | |
Cash and cash equivalents | $ | 3,182 | | | $ | 2,802 | | | $ | 2,511 | |
Restricted cash | 20 | | | 20 | | | 20 | |
Cash, cash equivalents and restricted cash, at end of period | $ | 3,202 | | | $ | 2,822 | | | $ | 2,531 | |
| | | | | |
Supplemental disclosure of cash flow information | | | | | |
Cash paid during the period for: | | | | | |
Interest expense | $ | 156 | | | $ | 168 | | | $ | 170 | |
Income taxes, net of income tax refunds | $ | (70) | | | $ | (31) | | | $ | 20 | |
| | | | | |
26. Subsequent Events
The Company has evaluated events and transactions that have occurred subsequent to December 31, 2021, and determined that there were no subsequent events that would require recognition or disclosure in the consolidated financial statements.
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 Rates Committee
•ASC: Accounting Standards Codification
•ASU: Accounting Standards Update
•BCBS: Basel Committee on Banking Supervision
•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
•CEO: Chief Executive Officer
•CET1: Common Equity Tier 1
•CFPB: Consumer Financial Protection Bureau
•CLDC: Compensation and Leadership Development Committee
•CME: Chicago Mercantile Exchange
•COSO: Committee of Sponsoring Organizations of the Treadway Commission
•COVID-19: Coronavirus Disease 2019
•CPPA: California Privacy Protection Agency
•CPRA: California Privacy Rights Act
•CRM: Corporate Risk Management
•CRO: Chief Risk Officer
•DCENT: Discover Card Execution Note Trust
•DCMT: Discover Card Master Trust
•DE&I: Diversity, Equity and Inclusion
•DFS: Discover Financial Services
•DRR: Designated Reserve Ratio
•EGRRCPA: Economic Growth, Regulatory Relief, and Consumer Protection Act
•EPS: Earnings Per Share
•ESG: Environmental, Social and Governance
•EWI: Early Warning Indicator
•FASB: Financial Accounting Standards Board
•FCA: UK Financial Conduct Authority
•FDIA: Federal Deposit Insurance Act
•FDIC: Federal Deposit Insurance Corporation
•FFIEC: Federal Financial Institutions Examination Council
•FHLB: Federal Home Loan Bank
•GAAP: Accounting Principles Generally Accepted in the United States
•IRS: Internal Revenue Service
•KRI: Key Risk Indicator
•LFI: Large Financial Institution
•LIBOR: London Interbank Offered Rate
•OCI: Other Comprehensive Income (Loss)
•OIS: Overnight Index Swap
•PCAOB: Public Company Accounting Oversight Board
•PCD: Purchased Credit-Deteriorated
•POS: Point-of-sale
•PSU: Performance Stock Unit
•Repo: Repurchase Agreement
•RMBS: Residential Mortgage-Backed Securities
•RSU: Restricted Stock Unit
•SaP: Skip-a-Pay (payment deferral)
•SCB: Stress Capital Buffer
•SEC: Securities and Exchange Commission
•SOFR: Secured Overnight Financing Rate
•TDR: Troubled Debt Restructuring
•U.S.: United States of America
•U.S. GSE: Government-sponsored Enterprises of the United States of America
•USD: U.S. Dollar
•VIE: Variable Interest Entity