Item 1. Financial Statements
DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Financial Condition (unaudited)
(dollars in millions, except for share amounts)
| | | | | | | | | | | |
| June 30,
2022 | | December 31,
2021 |
| |
| Assets | | | |
| Cash and cash equivalents | $ | 11,439 | | | $ | 8,750 | |
| Restricted cash | 32 | | | 2,582 | |
| | | |
Investment securities (includes available-for-sale securities of $5,328 and $6,700 reported at fair value with associated amortized cost of $5,390 and $6,549 at June 30, 2022 and December 31, 2021, respectively) | 5,536 | | | 6,904 | |
| Loan receivables | | | |
| Loan receivables | 99,301 | | | 93,684 | |
| Allowance for credit losses | (6,757) | | | (6,822) | |
| Net loan receivables | 92,544 | | | 86,862 | |
| Premises and equipment, net | 984 | | | 983 | |
| Goodwill | 255 | | | 255 | |
| | | |
| Other assets | 3,810 | | | 3,906 | |
| Total assets | $ | 114,600 | | | $ | 110,242 | |
| Liabilities and Stockholders' Equity | | | |
| Liabilities | | | |
| Deposits | | | |
| Interest-bearing deposit accounts | $ | 74,898 | | | $ | 70,818 | |
| Non-interest bearing deposit accounts | 1,514 | | | 1,575 | |
| Total deposits | 76,412 | | | 72,393 | |
| Short-term borrowings | 1,800 | | | 1,750 | |
| Long-term borrowings | 18,185 | | | 18,477 | |
| Accrued expenses and other liabilities | 4,439 | | | 4,214 | |
| Total liabilities | 100,836 | | | 96,834 | |
| Commitments, contingencies and guarantees (Notes 9, 12 and 13) | | | |
| Stockholders' Equity | | | |
Common stock, par value $0.01 per share; 2,000,000,000 shares authorized; 569,563,917 and 568,830,897 shares issued at June 30, 2022 and December 31, 2021, respectively | 6 | | | 6 | |
Preferred stock, par value $0.01 per share; 200,000,000 shares authorized; 10,700 shares issued and outstanding at June 30, 2022 and December 31, 2021, respectively | 1,056 | | | 1,056 | |
| Additional paid-in capital | 4,417 | | | 4,369 | |
| Retained earnings | 26,776 | | | 24,766 | |
| Accumulated other comprehensive loss | (251) | | | (94) | |
Treasury stock, at cost; 294,295,564 and 280,502,577 shares at June 30, 2022 and December 31, 2021, respectively | (18,240) | | | (16,695) | |
| Total stockholders' equity | 13,764 | | | 13,408 | |
| Total liabilities and stockholders' equity | $ | 114,600 | | | $ | 110,242 | |
| | | |
The table below presents the carrying amounts of certain assets and liabilities of Discover Financial Services' consolidated variable interest entities ("VIEs"), which are included in the condensed consolidated statements of financial condition above. The assets in the table below include those assets that can only be used to settle obligations of the consolidated VIEs. The liabilities in the table below include third-party liabilities of consolidated VIEs only and exclude intercompany balances that eliminate in consolidation. The liabilities also exclude amounts for which creditors have recourse to the general credit of Discover Financial Services.
| | | | | | | | | | | |
| June 30,
2022 | | December 31,
2021 |
| Assets | | | |
| Restricted cash | $ | 32 | | | $ | 2,582 | |
| Loan receivables | $ | 24,990 | | | $ | 25,449 | |
| Allowance for credit losses allocated to securitized loan receivables | $ | (1,209) | | | $ | (1,371) | |
| Other assets | $ | 4 | | | $ | 4 | |
| Liabilities | | | |
| Short- and long-term borrowings | $ | 9,099 | | | $ | 9,539 | |
| Accrued expenses and other liabilities | $ | 8 | | | $ | 6 | |
| | | |
See Notes to the Condensed Consolidated Financial Statements.
1
DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Income (unaudited)
(dollars in millions, except for share amounts)
| | | | | | | | | | | | | | | | | | | | | | | |
| | For the Three Months Ended June 30, | | For the Six Months Ended June 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
| Interest income | | | | | | | |
| Credit card loans | $ | 2,424 | | | $ | 2,105 | | | $ | 4,692 | | | $ | 4,259 | |
| Other loans | 439 | | | 431 | | | 867 | | | 868 | |
| Investment securities | 33 | | | 47 | | | 69 | | | 97 | |
| Other interest income | 19 | | | 6 | | | 23 | | | 11 | |
| Total interest income | 2,915 | | | 2,589 | | | 5,651 | | | 5,235 | |
| Interest expense | | | | | | | |
| Deposits | 174 | | | 170 | | | 313 | | | 363 | |
| Short-term borrowings | — | | | — | | | 1 | | | — | |
| Long-term borrowings | 131 | | | 120 | | | 248 | | | 243 | |
| Total interest expense | 305 | | | 290 | | | 562 | | | 606 | |
| Net interest income | 2,610 | | | 2,299 | | | 5,089 | | | 4,629 | |
| Provision for credit losses | 549 | | | 135 | | | 703 | | | (230) | |
| Net interest income after provision for credit losses | 2,061 | | | 2,164 | | | 4,386 | | | 4,859 | |
| Other income | | | | | | | |
| Discount and interchange revenue, net | 390 | | | 339 | | | 710 | | | 580 | |
| Protection products revenue | 42 | | | 43 | | | 86 | | | 86 | |
| Loan fee income | 142 | | | 105 | | | 282 | | | 212 | |
| Transaction processing revenue | 61 | | | 58 | | | 118 | | | 109 | |
| Unrealized (losses) gains on equity investments | (169) | | | 729 | | | (357) | | | 729 | |
| Realized gains on equity investments | 127 | | | — | | | 153 | | | — | |
| Other income | 21 | | | 6 | | | 45 | | | 29 | |
| Total other income | 614 | | | 1,280 | | | 1,037 | | | 1,745 | |
| Other expense | | | | | | | |
| Employee compensation and benefits | 515 | | | 498 | | | 1,015 | | | 1,004 | |
| Marketing and business development | 254 | | | 175 | | | 446 | | | 329 | |
| Information processing and communications | 121 | | | 145 | | | 246 | | | 254 | |
| Professional fees | 189 | | | 187 | | | 366 | | | 369 | |
| Premises and equipment | 24 | | | 22 | | | 48 | | | 46 | |
| Other expense | 120 | | | 195 | | | 232 | | | 301 | |
| Total other expense | 1,223 | | | 1,222 | | | 2,353 | | | 2,303 | |
| Income before income taxes | 1,452 | | | 2,222 | | | 3,070 | | | 4,301 | |
| Income tax expense | 341 | | | 524 | | | 717 | | | 1,010 | |
| Net income | $ | 1,111 | | | $ | 1,698 | | | $ | 2,353 | | | $ | 3,291 | |
| Net income allocated to common stockholders | $ | 1,105 | | | $ | 1,688 | | | $ | 2,309 | | | $ | 3,234 | |
| Basic earnings per common share | $ | 3.96 | | | $ | 5.56 | | | $ | 8.19 | | | $ | 10.60 | |
| Diluted earnings per common share | $ | 3.96 | | | $ | 5.55 | | | $ | 8.18 | | | $ | 10.59 | |
| | | | | | | |
See Notes to the Condensed Consolidated Financial Statements.
2
DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Comprehensive Income (unaudited)
(dollars in millions)
| | | | | | | | | | | | | | | | | | | | | | | |
| | For the Three Months Ended June 30, | | For the Six Months Ended June 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
| Net income | $ | 1,111 | | | $ | 1,698 | | | $ | 2,353 | | | $ | 3,291 | |
| Other comprehensive loss, net of tax | | | | | | | |
| Unrealized losses on available-for-sale investment securities, net of tax | (41) | | | (33) | | | (162) | | | (86) | |
| Unrealized gains on cash flow hedges, net of tax | 3 | | | 1 | | | 5 | | | 2 | |
| | | | | | | |
| Other comprehensive loss | (38) | | | (32) | | | (157) | | | (84) | |
| Comprehensive income | $ | 1,073 | | | $ | 1,666 | | | $ | 2,196 | | | $ | 3,207 | |
| | | | | | | |
See Notes to the Condensed Consolidated Financial Statements.
3
DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Changes in Stockholders' Equity (unaudited)
(dollars in millions, shares in thousands)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | Additional
Paid-in
Capital | | Retained
Earnings | | Accumulated Other Comprehensive Loss | | Treasury
Stock | | Total
Stockholders'
Equity |
| Preferred Stock | | Common Stock | | | | | |
| | Shares | | Amount | | Shares | | Amount | | | | | |
| For the Three Months Ended June 30, 2021 |
| Balance at March 31, 2021 | 11 | | | $ | 1,056 | | | 568,580 | | | $ | 6 | | | $ | 4,280 | | | $ | 21,373 | | | $ | (7) | | | $ | (14,554) | | | $ | 12,154 | |
| Net income | — | | | — | | | — | | | — | | | — | | | 1,698 | | | — | | | — | | | 1,698 | |
| Other comprehensive loss | — | | | — | | | — | | | — | | | — | | | — | | | (32) | | | — | | | (32) | |
| Purchases of treasury stock | — | | | — | | | — | | | — | | | — | | | — | | | — | | | (553) | | | (553) | |
| Common stock issued under employee benefit plans | — | | | — | | | 20 | | | — | | | 3 | | | — | | | — | | | — | | | 3 | |
| Common stock issued and stock-based compensation expense | — | | | — | | | 93 | | | — | | | 36 | | | — | | | — | | | — | | | 36 | |
| | | | | | | | | | | | | | | | | |
Dividends — common stock ($0.44 per share) | — | | | — | | | — | | | — | | | — | | | (135) | | | — | | | — | | | (135) | |
| | | | | | | | | | | | | | | | | |
| Balance at June 30, 2021 | 11 | | | $ | 1,056 | | | 568,693 | | | $ | 6 | | | $ | 4,319 | | | $ | 22,936 | | | $ | (39) | | | $ | (15,107) | | | $ | 13,171 | |
| | | | | | | | | | | | | | | | | |
| For the Three Months Ended June 30, 2022 |
| Balance at March 31, 2022 | 11 | | | $ | 1,056 | | | 569,504 | | | $ | 6 | | | $ | 4,390 | | | $ | 25,833 | | | $ | (213) | | | $ | (17,639) | | | $ | 13,433 | |
| Net income | — | | | — | | | — | | | — | | | — | | | 1,111 | | | — | | | — | | | 1,111 | |
| Other comprehensive loss | — | | | — | | | — | | | — | | | — | | | — | | | (38) | | | — | | | (38) | |
| Purchases of treasury stock | — | | | — | | | — | | | — | | | — | | | — | | | — | | | (601) | | | (601) | |
| Common stock issued under employee benefit plans | — | | | — | | | 27 | | | — | | | 3 | | | — | | | — | | | — | | | 3 | |
| Common stock issued and stock-based compensation expense | — | | | — | | | 33 | | | — | | | 24 | | | — | | | — | | | — | | | 24 | |
| | | | | | | | | | | | | | | | | |
Dividends — common stock ($0.60 per share) | — | | | — | | | — | | | — | | | — | | | (168) | | | — | | | — | | | (168) | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Balance at June 30, 2022 | 11 | | | $ | 1,056 | | | 569,564 | | | $ | 6 | | | $ | 4,417 | | | $ | 26,776 | | | $ | (251) | | | $ | (18,240) | | | $ | 13,764 | |
| | | | | | | | | | | | | | | | | |
| For the Six Months Ended June 30, 2021 |
| Balance at December 31, 2020 | 11 | | | $ | 1,056 | | | 567,898 | | | $ | 6 | | | $ | 4,257 | | | $ | 19,955 | | | $ | 45 | | | $ | (14,435) | | | $ | 10,884 | |
| | | | | | | | | | | | | | | | | |
| Net income | — | | | — | | | — | | | — | | | — | | | 3,291 | | | — | | | — | | | 3,291 | |
| Other comprehensive loss | — | | | — | | | — | | | — | | | — | | | — | | | (84) | | | — | | | (84) | |
| Purchases of treasury stock | — | | | — | | | — | | | — | | | — | | | — | | | — | | | (672) | | | (672) | |
| Common stock issued under employee benefit plans | — | | | — | | | 46 | | | — | | | 5 | | | — | | | — | | | — | | | 5 | |
| Common stock issued and stock-based compensation expense | — | | | — | | | 749 | | | — | | | 57 | | | — | | | — | | | — | | | 57 | |
| | | | | | | | | | | | | | | | | |
Dividends — common stock ($0.88 per share) | — | | | — | | | — | | | — | | | — | | | (271) | | | — | | | — | | | (271) | |
Dividends — Series C preferred stock ($2,750 per share) | — | | | — | | | — | | | — | | | — | | | (16) | | | — | | | — | | | (16) | |
Dividends — Series D preferred stock ($4,611 per share) | — | | | — | | | — | | | — | | | — | | | (23) | | | — | | | — | | | (23) | |
| Balance at June 30, 2021 | 11 | | | $ | 1,056 | | | 568,693 | | | $ | 6 | | | $ | 4,319 | | | $ | 22,936 | | | $ | (39) | | | $ | (15,107) | | | $ | 13,171 | |
| | | | | | | | | | | | | | | | | |
| For the Six Months Ended June 30, 2022 |
| Balance at December 31, 2021 | 11 | | | $ | 1,056 | | | 568,831 | | | $ | 6 | | | $ | 4,369 | | | $ | 24,766 | | | $ | (94) | | | $ | (16,695) | | | $ | 13,408 | |
| Net income | — | | | — | | | — | | | — | | | — | | | 2,353 | | | — | | | — | | | 2,353 | |
| Other comprehensive loss | — | | | — | | | — | | | — | | | — | | | — | | | (157) | | | — | | | (157) | |
| Purchases of treasury stock | — | | | — | | | — | | | — | | | — | | | — | | | — | | | (1,545) | | | (1,545) | |
| Common stock issued under employee benefit plans | — | | | — | | | 49 | | | — | | | 5 | | | — | | | — | | | — | | | 5 | |
| Common stock issued and stock-based compensation expense | — | | | — | | | 684 | | | — | | | 43 | | | — | | | — | | | — | | | 43 | |
| | | | | | | | | | | | | | | | | |
Dividends — common stock ($1.10 per share) | — | | | — | | | — | | | — | | | — | | | (312) | | | — | | | — | | | (312) | |
Dividends — Series C preferred stock ($2,750 per share) | — | | | — | | | — | | | — | | | — | | | (16) | | | — | | | — | | | (16) | |
Dividends — Series D preferred stock ($3,062.50 per share) | — | | | — | | | — | | | — | | | — | | | (15) | | | — | | | — | | | (15) | |
| Balance at June 30, 2022 | 11 | | | $ | 1,056 | | | 569,564 | | | $ | 6 | | | $ | 4,417 | | | $ | 26,776 | | | $ | (251) | | | $ | (18,240) | | | $ | 13,764 | |
| | | | | | | | | | | | | | | | | |
See Notes to the Condensed Consolidated Financial Statements.
4
DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Cash Flows (unaudited)
(dollars in millions) | | | | | | | | | | | |
| | For the Six Months Ended June 30, |
| | 2022 | | 2021 |
| Cash flows provided by operating activities | | | |
| Net income | $ | 2,353 | | | $ | 3,291 | |
| Adjustments to reconcile net income to net cash provided by operating activities: | | | |
| Provision for credit losses | 703 | | | (230) | |
| Deferred income taxes | (140) | | | 439 | |
| Depreciation and amortization | 279 | | | 248 | |
| Amortization of deferred revenues | (162) | | | (144) | |
| Net unrealized and realized losses (gains) on investments and other assets | 226 | | | (708) | |
| Other, net | 48 | | | 201 | |
| Changes in assets and liabilities: | | | |
| Increase in other assets | (262) | | | (210) | |
| Increase in accrued expenses and other liabilities | 301 | | | 169 | |
| Net cash provided by operating activities | 3,346 | | | 3,056 | |
| | | |
| Cash flows provided by investing activities | | | |
| Maturities of other short-term investments | — | | | 2,200 | |
| | | |
| Maturities of available-for-sale investment securities | 1,160 | | | 934 | |
| | | |
| Maturities of held-to-maturity investment securities | 22 | | | 45 | |
| Purchases of held-to-maturity investment securities | (27) | | | (25) | |
| Net change in principal on loans originated for investment | (6,290) | | | 1,925 | |
| | | |
| Proceeds from the sale of other investments | 216 | | | — | |
| Purchases of other investments | (115) | | | (41) | |
| | | |
| Purchases of premises and equipment | (99) | | | (97) | |
| Net cash (used for) provided by investing activities | (5,133) | | | 4,941 | |
| | | |
| Cash flows used for by financing activities | | | |
| Net change in short-term borrowings | 50 | | | — | |
| Net change in deposits | 4,007 | | | (2,439) | |
| Proceeds from issuance of securitized debt | 2,635 | | | — | |
| Maturities and repayment of securitized debt | (2,561) | | | (1,639) | |
| | | |
| Maturities and repayment of other long-term borrowings | (322) | | | (163) | |
| Proceeds from issuance of common stock | 5 | | | 5 | |
| Purchases of treasury stock | (1,545) | | | (672) | |
| | | |
| Dividends paid on common and preferred stock | (343) | | | (310) | |
| Net cash provided by (used for) financing activities | 1,926 | | | (5,218) | |
| Net increase in cash, cash equivalents and restricted cash | 139 | | | 2,779 | |
| Cash, cash equivalents and restricted cash, at the beginning of the period | 11,332 | | | 13,589 | |
| Cash, cash equivalents and restricted cash, at the end of the period | $ | 11,471 | | | $ | 16,368 | |
| | | |
| Reconciliation of cash, cash equivalents and restricted cash | | | |
| Cash and cash equivalents | $ | 11,439 | | | $ | 15,445 | |
| Restricted cash | 32 | | | 923 | |
| Cash, cash equivalents and restricted cash, at the end of the period | $ | 11,471 | | | $ | 16,368 | |
| | | |
| | | |
| | | |
| | | |
See Notes to the Condensed Consolidated Financial Statements.
5
Notes to the Condensed Consolidated Financial Statements
(unaudited)
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 and a financial holding company under the Gramm-Leach-Bliley Act. Therefore, the Company is subject to oversight, regulation and examination by the Board of Governors of the Federal Reserve System (the "Federal Reserve"). The Company provides digital banking products and services and payment services through its subsidiaries. The Company offers its customers credit card loans, private student loans, personal loans, home loans and deposit products. The Company also operates the Discover Network, the PULSE network ("PULSE") and Diners Club International ("Diners Club"), collectively known as the Discover Global Network. The Discover Network processes transactions for Discover-branded credit and debit cards and provides payment transaction processing and settlement services. PULSE operates an electronic funds transfer network, providing financial institutions issuing debit cards on the PULSE network with access to ATMs domestically and internationally, as well as merchant acceptance throughout the United States of America ("U.S.") for debit card transactions. Diners Club is a global payments network of licensees, which are generally financial institutions, that issue Diners Club branded credit and charge cards and/or provide card acceptance services.
The Company manages its business activities in two segments, Digital Banking and Payment Services, based on the products and services provided. See Note 16: Segment Disclosures for a detailed description of each segment's operations and the allocation conventions used in business segment reporting.
Basis of Presentation
The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the U.S. ("GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete consolidated financial statements. In the opinion of management, the financial statements reflect all adjustments necessary for the fair presentation of results for the interim period. All such adjustments are of a normal, recurring nature. The preparation of financial statements in conformity with GAAP requires the Company to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and related disclosures. These estimates are based on information available as of the date of the condensed consolidated financial statements. The Company believes that the estimates used in the preparation of the condensed consolidated financial statements are reasonable. Actual results could differ from these estimates. These interim condensed consolidated financial statements should be read in conjunction with the Company's 2021 audited consolidated financial statements filed with the Company's annual report on Form 10-K for the year ended December 31, 2021.
Recently Issued Accounting Pronouncements (Not Yet Adopted)
In March 2022, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2022-02, Financial Instruments—Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. The ASU eliminates the troubled debt restructuring ("TDR") recognition and measurement guidance and enhances disclosures for modifications of receivables from borrowers experiencing financial difficulty. ASU 2022-02 no longer requires the application of a discounted cash flow method for any modified receivables when measuring expected credit losses. The ASU also refines existing credit-related disclosures by requiring disclosure of current-period gross charge-offs of receivables by year of origination. The amendments in the ASU are to be applied prospectively to modifications and disclosures of gross charge-offs; however, adoption on a modified retrospective basis is permitted for the effect on the allowance for credit losses related to the elimination of the TDR recognition and measurement guidance. The ASU is effective for the Company on January 1, 2023. Management does not expect the amendments to have a material impact on the Company's financial statements.
2. Investments
The Company's investment securities consist of the following (dollars in millions): | | | | | | | | | | | |
| June 30,
2022 | | December 31,
2021 |
| | | |
| | | |
| | | |
| | | |
U.S. Treasury(1) and U.S. GSE(2) securities | $ | 5,186 | | | $ | 6,514 | |
Residential mortgage-backed securities - Agency(2) | 350 | | | 390 | |
| Total investment securities | $ | 5,536 | | | $ | 6,904 | |
| | | |
(1)Includes $12 million and $27 million of U.S. Treasury securities pledged as swap collateral as of June 30, 2022 and December 31, 2021, respectively.
(2)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 |
| At June 30, 2022 | | | | | | | |
Available-for-Sale Investment Securities(1) | | | | | | | |
| U.S. Treasury and U.S. GSE securities | $ | 5,245 | | | $ | 2 | | | $ | (61) | | | $ | 5,186 | |
| Residential mortgage-backed securities - Agency | 145 | | | — | | | (3) | | | 142 | |
| Total available-for-sale investment securities | $ | 5,390 | | | $ | 2 | | | $ | (64) | | | $ | 5,328 | |
Held-to-Maturity Investment Securities(2) | | | | | | | |
Residential mortgage-backed securities - Agency(3) | $ | 208 | | | $ | — | | | $ | (14) | | | $ | 194 | |
| Total held-to-maturity investment securities | $ | 208 | | | $ | — | | | $ | (14) | | | $ | 194 | |
| | | | | | | |
| At 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 | |
| | | | | | | |
(1)Available-for-sale investment securities are reported at fair value.
(2)Held-to-maturity investment securities are reported at amortized cost.
(3)Amounts represent residential mortgage-backed securities ("RMBS") that were classified as held-to-maturity as they were entered into as a part of the Company's community reinvestment initiatives.
The Company invests in U.S. Treasury obligations and securities issued by government agencies and government-sponsored enterprises of the U.S. ("U.S. GSEs"), which have long histories with no credit losses and are explicitly or implicitly guaranteed by the U.S. federal government. Therefore, management has concluded that there is no expectation of non-payment on its investment securities and does not record an allowance for credit losses on these investments.
The following table provides information about available-for-sale investment securities with aggregate gross unrealized losses and the length of time that individual investment securities have been in a continuous unrealized loss position (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Number of Securities in a Loss Position | | Less than 12 months | | More than 12 months |
| | Fair
Value | | Unrealized
Losses | | Fair
Value | | Unrealized
Losses |
| At June 30, 2022 | | | | | | | | | |
| Available-for-Sale Investment Securities | | | | | | | | | |
| U.S. Treasury and U.S. GSE securities | 33 | | | $ | 3,937 | | | $ | (61) | | | $ | — | | | $ | — | |
| Residential mortgage-backed securities - Agency | 27 | | | $ | 136 | | | $ | (3) | | | $ | 6 | | | $ | — | |
| | | | | | | | | |
| At December 31, 2021 | | | | | | | | | |
| Available-for-Sale Investment Securities | | | | | | | | | |
| U.S. Treasury and U.S. GSE securities | 2 | | | $ | 110 | | | NM | | $ | — | | | $ | — | |
| Residential mortgage-backed securities - Agency | 1 | | | $ | 7 | | | NM | | $ | — | | | $ | — | |
| | | | | | | | | |
There were no proceeds from sales or recognized gains or losses on available-for-sale securities during the three and six months ended June 30, 2022 and 2021. See Note 8: Accumulated Other Comprehensive Income for unrealized gains and losses on available-for-sale securities during the three and six months ended June 30, 2022 and 2021.
Maturities of available-for-sale debt securities and held-to-maturity debt securities are provided in the following table (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| At June 30, 2022 | 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 | $ | 1,720 | | | $ | 3,517 | | | $ | 8 | | | $ | — | | | $ | 5,245 | |
Residential mortgage-backed securities - Agency(1) | 1 | | | 88 | | | 49 | | | 7 | | | 145 | |
| Total available-for-sale investment securities | $ | 1,721 | | | $ | 3,605 | | | $ | 57 | | | $ | 7 | | | $ | 5,390 | |
| Held-to-Maturity Investment Securities — Amortized Cost | | | | | | | | | |
Residential mortgage-backed securities - Agency(1) | $ | — | | | $ | — | | | $ | — | | | $ | 208 | | | $ | 208 | |
| Total held-to-maturity investment securities | $ | — | | | $ | — | | | $ | — | | | $ | 208 | | | $ | 208 | |
| Available-for-Sale Investment Securities — Fair Values | | | | | | | | | |
| U.S. Treasury and U.S. GSE securities | $ | 1,719 | | | $ | 3,460 | | | $ | 7 | | | $ | — | | | $ | 5,186 | |
Residential mortgage-backed securities - Agency(1) | 1 | | | 86 | | | 49 | | | 6 | | | 142 | |
| Total available-for-sale investment securities | $ | 1,720 | | | $ | 3,546 | | | $ | 56 | | | $ | 6 | | | $ | 5,328 | |
| Held-to-Maturity Investment Securities — Fair Values | | | | | | | | | |
Residential mortgage-backed securities - Agency(1) | $ | — | | | $ | — | | | $ | — | | | $ | 194 | | | $ | 194 | |
| Total held-to-maturity investment securities | $ | — | | | $ | — | | | $ | — | | | $ | 194 | | | $ | 194 | |
| | | | | | | | | |
(1)Maturities of RMBS are reflective of the contractual maturities of the investment.
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 condensed consolidated statements of financial condition. The portion of each investment's operating results allocable to the Company reduces the carrying value of the investments and is recorded in other expense within the condensed consolidated statements of income. The Company further reduces the carrying value of the investments by recognizing any amounts that are in excess of future net tax benefits in other expense. The Company earns a return primarily through tax credits allocated to the affordable housing projects and the community revitalization projects. The Company does not consolidate these investments as the Company does not have a controlling financial interest in the investee entities. As of June 30, 2022 and December 31, 2021, the Company had outstanding
investments in these entities of $366 million and $388 million, respectively, and related contingent liabilities for unconditional and legally binding delayed equity contributions of $70 million and $92 million, respectively. Of the above outstanding equity investments, the Company had $334 million and $350 million of investments related to affordable housing projects as of June 30, 2022 and December 31, 2021, respectively, which had $60 million and $80 million of related contingent liabilities for unconditional and legally binding delayed equity contributions, respectively.
The Company holds non-controlling equity positions in several payment services entities. 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 June 30, 2022 and December 31, 2021, the carrying value of these investments, which are recorded within other assets on the Company's condensed consolidated statements of financial condition, was $39 million and $36 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 June 30, 2022 and December 31, 2021, the carrying value of these investments, which are recorded within other assets on the Company's condensed consolidated statements of financial condition, was $95 million and $461 million, respectively. During the three and six months ended June 30, 2022, the Company recognized unrealized losses of $169 million and $357 million, respectively, and realized gains of approximately $127 million and $150 million, respectively, on the condensed consolidated statements of income related to these investments. The Company recognized an unrealized gain of approximately $729 million during the three and six months ended June 30, 2021.
3. 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): | | | | | | | | | | | |
| June 30,
2022 | | December 31,
2021 |
Credit card loans(1)(2) | $ | 79,237 | | | $ | 74,369 | |
Other loans(3) | | | |
Private student loans(4) | 10,074 | | | 10,113 | |
| Personal loans | 7,145 | | | 6,936 | |
| Other loans | 2,845 | | | 2,266 | |
| Total other loans | 20,064 | | | 19,315 | |
| Total loan receivables | 99,301 | | | 93,684 | |
| Allowance for credit losses | (6,757) | | | (6,822) | |
| Net loan receivables | $ | 92,544 | | | $ | 86,862 | |
| | | |
(1)Amounts include carrying values of $12.3 billion and $13.3 billion underlying investors' interest in trust debt at June 30, 2022 and December 31, 2021, respectively, and $12.5 billion and $11.9 billion in seller's interest at June 30, 2022 and December 31, 2021, respectively. See Note 4: Credit Card and Private Student Loan Securitization Activities for additional information.
(2)Unbilled accrued interest receivable on credit card loans, which is presented as part of other assets in the Company's condensed consolidated statements of financial condition, was $447 million and $423 million at June 30, 2022 and December 31, 2021, respectively.
(3)Accrued interest receivable on private student, personal and other loans, which is presented as part of other assets in the Company's condensed consolidated statements of financial condition, was $457 million, $39 million and $8 million, respectively, at June 30, 2022 and $443 million, $42 million and $6 million, respectively, at December 31, 2021.
(4)Amounts include carrying values of $188 million and $207 million in loans pledged as collateral against the note issued from a private student loan securitization trust at June 30, 2022 and December 31, 2021, respectively. See Note 4: 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 |
| June 30, 2022 | | December 31, 2021 |
| | 660 and Above | | Less than 660
or No Score | | 660 and Above | | Less than 660
or No Score |
| $ | | % | | $ | | % | | $ | | % | | $ | | % |
Credit card loans(1) | $ | 66,006 | | | 83 | % | | $ | 13,231 | | | 17 | % | | $ | 62,262 | | | 84 | % | | $ | 12,107 | | | 16 | % |
Private student loans by origination year(2)(3) | | | | | | | | | | | | | | | |
| 2022 | $ | 328 | | | 95 | % | | $ | 16 | | | 5 | % | | | | | | | | |
| 2021 | 1,729 | | | 95 | % | | 87 | | | 5 | % | | $ | 1,251 | | | 94 | % | | $ | 73 | | | 6 | % |
| 2020 | 1,453 | | | 96 | % | | 62 | | | 4 | % | | 1,561 | | | 96 | % | | 59 | | | 4 | % |
| 2019 | 1,313 | | | 96 | % | | 61 | | | 4 | % | | 1,439 | | | 96 | % | | 61 | | | 4 | % |
| 2018 | 1,026 | | | 95 | % | | 58 | | | 5 | % | | 1,147 | | | 95 | % | | 59 | | | 5 | % |
| Prior | 3,714 | | | 94 | % | | 227 | | | 6 | % | | 4,215 | | | 94 | % | | 248 | | | 6 | % |
| Total private student loans | $ | 9,563 | | | 95 | % | | $ | 511 | | | 5 | % | | $ | 9,613 | | | 95 | % | | $ | 500 | | | 5 | % |
| Personal loans by origination year | | | | | | | | | | | | | | | |
| 2022 | $ | 2,113 | | | 99 | % | | $ | 17 | | | 1 | % | | | | | | | | |
| 2021 | 2,568 | | | 97 | % | | 67 | | | 3 | % | | $ | 3,326 | | | 99 | % | | $ | 37 | | | 1 | % |
| 2020 | 1,130 | | | 97 | % | | 39 | | | 3 | % | | 1,622 | | | 98 | % | | 39 | | | 2 | % |
| 2019 | 683 | | | 93 | % | | 48 | | | 7 | % | | 1,052 | | | 94 | % | | 62 | | | 6 | % |
| 2018 | 268 | | | 89 | % | | 32 | | | 11 | % | | 435 | | | 91 | % | | 44 | | | 9 | % |
| Prior | 153 | | | 85 | % | | 27 | | | 15 | % | | 276 | | | 87 | % | | 43 | | | 13 | % |
| Total personal loans | $ | 6,915 | | | 97 | % | | $ | 230 | | | 3 | % | | $ | 6,711 | | | 97 | % | | $ | 225 | | | 3 | % |
| | | | | | | | | | | | | | | |
(1)Amounts include $700 million and $813 million of revolving line-of-credit arrangements that were converted to term loans as a result of a troubled debt restructuring ("TDR") program as of June 30, 2022 and December 31, 2021, 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): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| June 30, 2022 | | December 31, 2021 |
| 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 | $ | 759 | | | $ | 633 | | | $ | 1,392 | | | $ | 670 | | | $ | 562 | | | $ | 1,232 | |
Private student loans by origination year(1) | | | | | | | | | | | |
| 2022 | $ | — | | | $ | — | | | $ | — | | | | | | | |
| 2021 | 2 | | | — | | | 2 | | | $ | — | | | $ | — | | | $ | — | |
| 2020 | 7 | | | 3 | | | 10 | | | 4 | | | 1 | | | 5 | |
| 2019 | 12 | | | 4 | | | 16 | | | 9 | | | 2 | | | 11 | |
| 2018 | 17 | | | 5 | | | 22 | | | 14 | | | 4 | | | 18 | |
| Prior | 90 | | | 28 | | | 118 | | | 94 | | | 29 | | | 123 | |
| Total private student loans | $ | 128 | | | $ | 40 | | | $ | 168 | | | $ | 121 | | | $ | 36 | | | $ | 157 | |
| Personal loans by origination year | | | | | | | | | | | |
| 2022 | $ | 2 | | | $ | — | | | $ | 2 | | | | | | | |
| 2021 | 9 | | | 3 | | | 12 | | | $ | 5 | | | $ | 1 | | | $ | 6 | |
| 2020 | 7 | | | 3 | | | 10 | | | 7 | | | 2 | | | 9 | |
| 2019 | 7 | | | 3 | | | 10 | | | 11 | | | 4 | | | 15 | |
| 2018 | 4 | | | 2 | | | 6 | | | 6 | | | 3 | | | 9 | |
| Prior | 3 | | | 2 | | | 5 | | | 6 | | | 3 | | | 9 | |
| Total personal loans | $ | 32 | | | $ | 13 | | | $ | 45 | | | $ | 35 | | | $ | 13 | | | $ | 48 | |
| | | | | | | | | | | |
(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 Three Months Ended June 30, 2022 |
| | Credit Card Loans | | Private Student Loans | | Personal Loans | | Other Loans | | Total Loans |
| Balance at March 31, 2022 | $ | 5,120 | | | $ | 870 | | | $ | 613 | | | $ | 44 | | | $ | 6,647 | |
| Additions | | | | | | | | | |
Provision for credit losses(1) | 568 | | | (11) | | | (20) | | | 2 | | | 539 | |
| Deductions | | | | | | | | | |
| Charge-offs | (587) | | | (33) | | | (39) | | | — | | | (659) | |
| Recoveries | 206 | | | 6 | | | 18 | | | — | | | 230 | |
| Net charge-offs | (381) | | | (27) | | | (21) | | | — | | | (429) | |
| Other | — | | | — | | | — | | | — | | | — | |
| Balance at June 30, 2022 | $ | 5,307 | | | $ | 832 | | | $ | 572 | | | $ | 46 | | | $ | 6,757 | |
| | | | | | | | | |
| For the Three Months Ended June 30, 2021 |
| | Credit Card Loans | | Private Student Loans | | Personal Loans | | Other Loans | | Total Loans |
| Balance at March 31, 2021 | $ | 5,640 | | | $ | 862 | | | $ | 804 | | | $ | 41 | | | $ | 7,347 | |
| Additions | | | | | | | | | |
Provision for credit losses(1) | 181 | | | (21) | | | (28) | | | 3 | | | 135 | |
| Deductions | | | | | | | | | |
| Charge-offs | (620) | | | (20) | | | (48) | | | — | | | (688) | |
| Recoveries | 208 | | | 7 | | | 17 | | | — | | | 232 | |
| Net charge-offs | (412) | | | (13) | | | (31) | | | — | | | (456) | |
| Other | — | | | — | | | — | | | — | | | — | |
| Balance at June 30, 2021 | $ | 5,409 | | | $ | 828 | | | $ | 745 | | | $ | 44 | | | $ | 7,026 | |
| | | | | | | | | |
| For the Six Months Ended June 30, 2022 |
| | Credit Card Loans | | Private Student Loans | | Personal Loans | | Other Loans | | Total Loans |
| Balance at December 31, 2021 | $ | 5,273 | | | $ | 843 | | | $ | 662 | | | $ | 44 | | | $ | 6,822 | |
| Additions | | | | | | | | | |
Provision for credit losses(1) | 746 | | | 34 | | | (50) | | | 2 | | | 732 | |
| Deductions | | | | | | | | | |
| Charge-offs | (1,128) | | | (57) | | | (77) | | | — | | | (1,262) | |
| Recoveries | 416 | | | 12 | | | 37 | | | — | | | 465 | |
| Net charge-offs | (712) | | | (45) | | | (40) | | | — | | | (797) | |
| Other | — | | | — | | | — | | | — | | | — | |
| Balance at June 30, 2022 | $ | 5,307 | | | $ | 832 | | | $ | 572 | | | $ | 46 | | | $ | 6,757 | |
| | | | | | | | | |
| For the Six Months Ended June 30, 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) | (196) | | | 15 | | | (32) | | | 6 | | | (207) | |
| Deductions | | | | | | | | | |
| Charge-offs | (1,283) | | | (40) | | | (112) | | | — | | | (1,435) | |
| Recoveries | 397 | | | 13 | | | 32 | | | — | | | 442 | |
| Net charge-offs | (886) | | | (27) | | | (80) | | | — | | | (993) | |
| Other | — | | | — | | | — | | | — | | | — | |
| Balance at June 30, 2021 | $ | 5,409 | | | $ | 828 | | | $ | 745 | | | $ | 44 | | | $ | 7,026 | |
| | | | | | | | | |
(1)Excludes a $10 million adjustment of the liability for expected credit losses on unfunded commitments for the three months ended June 30, 2022, and $29 million and $23 million for the six months ended June 30, 2022 and 2021, respectively, as the liability is recorded in accrued expenses and other liabilities in the Company's condensed consolidated statements of financial condition.
The allowance for credit losses was approximately $6.8 billion at June 30, 2022, which reflects a $110 million build over March 31, 2022 and a $65 million release from December 31, 2021. The build in the allowance for credit losses between June 30, 2022 and March 31, 2022, was driven by loan growth, partially offset by the continued strength of the loan portfolio's credit performance. The release in the allowance for credit losses between June 30, 2022 and December 31, 2021, was primarily driven by the continued strength of the loan portfolio's credit performance.
The allowance estimation process begins with a loss forecast that uses certain macroeconomic variables and multiple macroeconomic scenarios among its inputs. In estimating the allowance at June 30, 2022, the Company used a macroeconomic forecast that projected (i) a peak unemployment rate of 5.0%, decreasing to 4.6% through the end of 2022 and 2023; and (ii) 2.5% and 1.5% annualized growth in the real gross domestic product for 2022 and 2023, respectively. Labor market conditions, which historically have been an important determinant of credit loss trends, remain strong as of June 30, 2022. The unemployment rate and both initial and continuing jobless claims remain near their historical lows. In addition, a very high number of job openings indicates robust labor demand.
In estimating expected credit losses, the Company considered the uncertainties associated with borrower behavior and payment trends, as well as higher consumer price inflation experienced in the first half of 2022 and the fiscal and monetary policy responses to that inflation. During the first half of 2022, the Federal Reserve raised its benchmark federal funds rate multiple times and signaled additional rate hikes throughout the remainder of the year. In recognition of the evolving macroeconomic environment, the estimation of the allowance for credit losses has required significant management judgment.
The forecast period the Company deemed to be reasonable and supportable was 18 months for all periods presented. The 18-month reasonable and supportable forecast period was deemed appropriate given the current economic conditions 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. The Company applied a weighted reversion method to provide a more reasonable transition to historical losses for all loan products for all periods presented.
The net charge-offs for credit card and personal loans decreased for the three and six months ended June 30, 2022, when compared to the same periods in 2021. The decrease in net charge-offs for credit card was primarily driven by lower average balances at charge off. The decrease in net charge-offs for personal loans was mainly driven by the continued benefit from tighter credit underwriting standards implemented in 2020. The net charge-offs for private student loans increased for the three and six months ended June 30, 2022, when compared to the same periods in 2021. The increase in net charge-offs was driven by the normalization of credit and the diminishing benefit from pandemic programs.
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 Three Months Ended June 30, | | For the Six Months Ended June 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
| Interest and fees accrued subsequently charged-off, net of recoveries (recorded as a reduction of interest income) | $ | 69 | | | $ | 80 | | | $ | 135 | | | $ | 175 | |
| Fees accrued subsequently charged-off, net of recoveries (recorded as a reduction to other income) | $ | 23 | | | $ | 21 | | | $ | 44 | | | $ | 44 | |
| | | | | | | |
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) |
| At June 30, 2022 | | | | | | | | | |
| Credit card loans | $ | 759 | | | $ | 633 | | | $ | 1,392 | | | $ | 613 | | | $ | 165 | |
| Other loans | | | | | | | | | |
| Private student loans | 128 | | | 40 | | | 168 | | | 39 | | | 7 | |
| Personal loans | 32 | | | 13 | | | 45 | | | 12 | | | 7 | |
| Other loans | 8 | | | 8 | | | 16 | | | 1 | | | 20 | |
| Total other loans | 168 | | | 61 | | | 229 | | | 52 | | | 34 | |
| Total loan receivables | $ | 927 | | | $ | 694 | | | $ | 1,621 | | | $ | 665 | | | $ | 199 | |
| | | | | | | | | |
| At 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 | |
| | | | | | | | | |
(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 $5 million and $7 million for the three months ended June 30, 2022 and 2021, respectively, and $11 million and $15 million for the six months ended June 30, 2022 and 2021, 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 loans, 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 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. The Company evaluates new programs to determine which of them meet the definition of a TDR. 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, generally 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 June 30, 2022 and December 31, 2021, there were $5.7 billion and $5.8 billion, respectively, of private student loans in repayment and $75 million and $64 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 and, in certain circumstances, the interest rate on the loan is reduced. The permanent programs involve extending the loan term and, in certain circumstances, reducing the interest rate on the loan. The total term of the loan, including modification, may not exceed 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 three and six months ended June 30, 2022 and 2021, the Company quantified the amount by which interest and fees were reduced during the periods. During the three months ended June 30, 2022 and 2021, the Company forgave approximately $6 million and $9 million, respectively, of interest and fees resulting from accounts entering into a credit card loan TDR program. During the six months ended June 30, 2022 and 2021, the Company forgave approximately $13 million and $21 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.
The following table provides information on loans that entered a TDR program during the period (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | |
| For the Three Months Ended June 30, |
| 2022 | | 2021 |
| Number of Accounts | | Balances | | Number of Accounts | | Balances |
| Accounts that entered a TDR program during the period | | | | | | | |
Credit card loans(1) | 49,341 | | | $ | 313 | | | 14,221 | | | $ | 94 | |
| Private student loans | 1,523 | | | $ | 29 | | | 127 | | | $ | 3 | |
| Personal loans | 1,603 | | | $ | 22 | | | 824 | | | $ | 11 | |
| | | | | | | |
| For the Six Months Ended June 30, |
| 2022 | | 2021 |
| Number of Accounts | | Balances | | Number of Accounts | | Balances |
| Accounts that entered a TDR program during the period | | | | | | | |
Credit card loans(1) | 103,852 | | | $ | 657 | | | 34,923 | | | $ | 229 | |
| Private student loans | 3,278 | | | $ | 60 | | | 253 | | | $ | 5 | |
| Personal loans | 2,762 | | | $ | 37 | | | 2,214 | | | $ | 28 | |
| | | | | | | |
(1)Accounts that entered a credit card TDR program include $71 million and $88 million that were converted from revolving line-of-credit arrangements to term loans during the three months ended June 30, 2022 and 2021, respectively, and $146 million and $216 million for the six months ended June 30, 2022 and 2021, respectively.
The number and balance of enrollments in credit card, private student loan and personal loan modification programs designated as TDRs increased during the three and six months ended June 30, 2022, when compared to the same periods in 2021. The increase is primarily due to the favorable impact of the accounting and financial reporting exemptions provided by the CARES Act, which expired on January 1, 2022, for three and six months ended June 30, 2021.
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 Three Months Ended June 30, |
| 2022 | | 2021 |
| 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) | 5,703 | | | $ | 28 | | | 4,525 | | | $ | 27 | |
Private student loans(3) | 161 | | | $ | 3 | | | 65 | | | $ | 1 | |
Personal loans(2) | 275 | | | $ | 4 | | | 361 | | | $ | 5 | |
| | | | | | | |
| For the Six Months Ended June 30, |
| 2022 | | 2021 |
| 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) | 10,238 | | | $ | 51 | | | 10,526 | | | $ | 63 | |
Private student loans(3) | 267 | | | $ | 5 | | | 131 | | | $ | 3 | |
Personal loans(2) | 536 | | | $ | 7 | | | 888 | | | $ | 12 | |
| | | | | | | |
(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 three months ended June 30, 2022 and 2021, approximately 62% and 68%, respectively, and for the six months ended June 30, 2022 and 2021, approximately 63% and 68%, 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.”
4. 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 to the consolidated financial statements in the Company's annual report on Form 10-K for the year ended December 31, 2021.
Credit Card Securitization Activities
The Company accesses the term asset securitization market through the Discover Card Master Trust I ("DCMT") and the Discover Card Execution Note Trust ("DCENT"). Credit card loan receivables are transferred into DCMT and beneficial interests in DCMT are transferred into DCENT. DCENT issues debt securities to investors that are reported primarily in long-term borrowings.
The DCENT debt structure consists of 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 condensed consolidated statements of financial condition.
Upon transfer of credit card loan receivables to the trust, the receivables and certain cash flows derived from them become restricted for use in meeting obligations to the trust's creditors. Further, the transferred credit card loan receivables are owned by the trust and are not available to the Company's third-party creditors. The trusts have ownership of cash balances, the amounts of which are reported in restricted cash within the Company's condensed consolidated statements of financial condition. Except for the seller's interest in trust receivables, the Company's interests in trust assets are generally subordinate to the interests of third-party investors in trust debt and, as such, may not be realized by the Company if needed to absorb deficiencies in cash flows that are allocated to those investors. Apart from the restricted assets related to securitization activities, the investors and the securitization trusts have no recourse to the Company's other assets or the Company's general credit for a shortage in cash flows.
The carrying values of these restricted assets, which are presented on the Company's condensed consolidated statements of financial condition as relating to securitization activities, are shown in the following table (dollars in millions): | | | | | | | | | | | |
| June 30,
2022 | | December 31,
2021 |
| Restricted cash | $ | 24 | | | $ | 2,574 | |
| | | |
| Investors' interests held by third-party investors | 9,025 | | | 9,425 | |
| Investors' interests held by wholly owned subsidiaries of Discover Bank | 3,231 | | | 3,899 | |
| Seller's interest | 12,546 | | | 11,918 | |
Loan receivables(1) | 24,802 | | | 25,242 | |
Allowance for credit losses allocated to securitized loan receivables(1) | (1,209) | | | (1,371) | |
| Net loan receivables | 23,593 | | | 23,871 | |
| Other assets | 3 | | | 3 | |
| Carrying value of assets of consolidated variable interest entities | $ | 23,620 | | | $ | 26,448 | |
| | | |
(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 June 30, 2022, 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 condensed consolidated statements of financial condition as relating to securitization activities, are shown in the following table (dollars in millions): | | | | | | | | | | | |
| | June 30,
2022 | | December 31,
2021 |
| Restricted cash | $ | 8 | | | $ | 8 | |
| Private student loan receivables | 188 | | | 207 | |
| Carrying value of assets of consolidated variable interest entities | $ | 196 | | | $ | 215 | |
| | | |
5. Deposits
The Company offers its deposit products to customers through two channels: (i) direct marketing, internet origination and affinity relationships ("direct-to-consumer deposits"); and (ii) 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.
The following table summarizes certificates of deposits maturing over the remainder of this year, over each of the next four years and thereafter (dollars in millions): | | | | | |
| At June 30, 2022 |
| 2022 | $ | 8,662 | |
| 2023 | 7,636 | |
| 2024 | 2,853 | |
| 2025 | 1,585 | |
| 2026 | 888 | |
| Thereafter | 1,334 | |
| Total | $ | 22,958 | |
| |
6. 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): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| June 30, 2022 | | December 31, 2021 |
| Maturity | | Interest
Rate | | Weighted-Average Interest Rate | | Outstanding Amount | | Outstanding Amount |
| Securitized Debt | | | | | | | | | |
Fixed-rate asset-backed securities(1) | 2022-2026 | | 0.58% - 3.32% | | 2.05% | | $ | 6,408 | | | $ | 5,588 | |
Floating-rate asset-backed securities(2) | 2022-2024 | | 1.65% - 1.92% | | 1.77% | | 2,598 | | | 3,347 | |
| Total Discover Card Master Trust I and Discover Card Execution Note Trust | | | | | | | 9,006 | | | 8,935 | |
| | | | | | | | | |
Floating-rate asset-backed security(3)(4) | 2031 | | 5.75% | | 5.75% | | 93 | | | 104 | |
| Total private student loan securitization trust | | | | | | | 93 | | | 104 | |
| Total long-term borrowings - owed to securitization investors | | | | | | | 9,099 | | | 9,039 | |
| | | | | | | | | |
| Discover Financial Services (Parent Company) | | | | | | | | | |
| Fixed-rate senior notes | 2022-2027 | | 3.75% - 4.50% | | 4.06% | | 3,080 | | | 3,382 | |
| Fixed-rate retail notes | 2022-2031 | | 2.85% - 4.40% | | 3.75% | | 166 | | | 166 | |
| | | | | | | | | |
| Discover Bank | | | | | | | | | |
Fixed-rate senior bank notes(1) | 2023-2030 | | 2.45% - 4.65% | | 3.63% | | 5,350 | | | 5,385 | |
Fixed-rate subordinated bank notes(1) | 2028 | | 4.68% | | 4.68% | | 490 | | | 505 | |
| Total long-term borrowings | | | | | | | $ | 18,185 | | | $ | 18,477 | |
| | | | | | | | | |
(1)The Company uses interest rate swaps to hedge portions of these long-term borrowings against changes in fair value attributable to changes in the London Interbank Offered Rate ("LIBOR") or Overnight Index Swap ("OIS") rates. The use of these interest rate swaps impacts the carrying value of the debt. See Note 15: Derivatives and Hedging Activities.
(2)DCENT floating-rate asset-backed securities include issuances with the following interest rate terms: 1-month LIBOR + 33 to 60 basis points as of June 30, 2022.
(3)The private 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 June 30, 2022.
(4)Repayment of this debt is dependent upon the timing of principal and interest payments on the underlying private student loans. The date shown represents the final maturity date.
The following table summarizes long-term borrowings maturing over the remainder of this year, over each of the next four years and thereafter (dollars in millions): | | | | | |
| June 30, 2022 |
| 2022 | $ | 2,322 | |
| 2023 | 3,284 | |
| 2024 | 3,730 | |
| 2025 | 3,171 | |
| 2026 | 2,661 | |
| Thereafter | 3,017 | |
| Total | $ | 18,185 | |
| |
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. At June 30, 2022, the Company had total committed borrowing capacity of $1.8 billion based on the amount and type of assets pledged, nearly all of which was outstanding as a short-term draw. At 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.
Additionally, the Company has access to committed borrowing capacity through private securitizations to support the funding of its credit card loan receivables. As of June 30, 2022, the total commitment of secured credit facilities through
private providers was $3.5 billion, none of which was drawn. 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. 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 and 2024. Borrowings outstanding under each facility bear interest at a margin above LIBOR, Term Secured Overnight Financing Rate ("SOFR") or the asset-backed commercial paper costs of each provider. The terms of each agreement provide for a commitment fee to be paid on the unused capacity and include various affirmative and negative covenants, including performance metrics and legal requirements similar to those required to issue any term securitization transaction.
7. Preferred Stock
The table below presents a summary of the Company's non-cumulative perpetual preferred stock that is outstanding at June 30, 2022 (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 June 30, 2022 | | Total Depositary Shares Authorized, Issued and Outstanding | | Carrying Value |
| | | | | June 30, 2022 | | December 31, 2021 | | June 30, 2022 | | December 31, 2021 |
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 five years to a fixed annual rate equal to the 5-year Treasury plus a spread of 5.783%.
8. Accumulated Other Comprehensive Income
Changes in each component of accumulated other comprehensive income ("AOCI") were as follows (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | |
| Unrealized (Losses) Gains on Available-for-Sale Investment Securities, Net of Tax | | Losses on Cash Flow Hedges, Net of Tax | | Losses on Pension Plan, Net of Tax | | AOCI |
| For the Three Months Ended June 30, 2022 | | | | | | | |
| Balance at March 31, 2022 | $ | (7) | | | $ | (7) | | | $ | (199) | | | $ | (213) | |
| Net change | (41) | | | 3 | | | — | | | (38) | |
| Balance at June 30, 2022 | $ | (48) | | | $ | (4) | | | $ | (199) | | | $ | (251) | |
| | | | | | | |
| For the Three Months Ended June 30, 2021 | | | | | | | |
| Balance at March 31, 2021 | $ | 231 | | | $ | (11) | | | $ | (227) | | | $ | (7) | |
| Net change | (33) | | | 1 | | | — | | | (32) | |
| Balance at June 30, 2021 | $ | 198 | | | $ | (10) | | | $ | (227) | | | $ | (39) | |
| | | | | | | |
| For the Six Months Ended June 30, 2022 | | | | | | | |
| Balance at December 31, 2021 | $ | 114 | | | $ | (9) | | | $ | (199) | | | $ | (94) | |
| Net change | (162) | | | 5 | | | — | | | (157) | |
| Balance at June 30, 2022 | $ | (48) | | | $ | (4) | | | $ | (199) | | | $ | (251) | |
| | | | | | | |
| For the Six Months Ended June 30, 2021 | | | | | | | |
| Balance at December 31, 2020 | $ | 284 | | | $ | (12) | | | $ | (227) | | | $ | 45 | |
| Net change | (86) | | | 2 | | | — | | | (84) | |
| Balance at June 30, 2021 | $ | 198 | | | $ | (10) | | | $ | (227) | | | $ | (39) | |
| | | | | | | |
The following table presents each component of other comprehensive income ("OCI") before reclassifications and amounts reclassified from AOCI for each component of OCI before- and after-tax (dollars in millions): | | | | | | | | | | | | | | | | | |
| Before Tax | | Tax Benefit (Expense) | | Net of Tax |
| For the Three Months Ended June 30, 2022 | | | | | |
| Available-for-Sale Investment Securities | | | | | |
| Net unrealized holding losses arising during the period | $ | (53) | | | $ | 12 | | | $ | (41) | |
| Amounts reclassified from AOCI | — | | | — | | | — | |
| Net change | $ | (53) | | | $ | 12 | | | $ | (41) | |
| Cash Flow Hedges | | | | | |
| Net unrealized gains arising during the period | $ | 3 | | | $ | (1) | | | $ | 2 | |
| Amounts reclassified from AOCI | 1 | | | — | | | 1 | |
| Net change | $ | 4 | | | $ | (1) | | | $ | 3 | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| For the Three Months Ended June 30, 2021 | | | | | |
| Available-for-Sale Investment Securities | | | | | |
| Net unrealized holding losses arising during the period | $ | (43) | | | $ | 10 | | | $ | (33) | |
| Amounts reclassified from AOCI | — | | | — | | | — | |
| Net change | $ | (43) | | | $ | 10 | | | $ | (33) | |
| Cash Flow Hedges | | | | | |
| | | | | |
| Amounts reclassified from AOCI | $ | 1 | | | $ | — | | | $ | 1 | |
| Net change | $ | 1 | | | $ | — | | | $ | 1 | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| For the Six Months Ended June 30, 2022 | | | | | |
| Available-for-Sale Investment Securities | | | | | |
| Net unrealized holding losses arising during the period | $ | (213) | | | $ | 51 | | | $ | (162) | |
| | | | | |
| Net change | $ | (213) | | | $ | 51 | | | $ | (162) | |
| Cash Flow Hedges | | | | | |
| Net unrealized gains arising during the period | $ | 2 | | | $ | (1) | | | $ | 1 | |
| Amounts reclassified from AOCI | 2 | | | 2 | | | 4 | |
| Net change | $ | 4 | | | $ | 1 | | | $ | 5 | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| For the Six Months Ended June 30, 2021 | |
| Available-for-Sale Investment Securities | | | | | |
| Net unrealized holding losses arising during the period | $ | (114) | | | $ | 28 | | | $ | (86) | |
| Amounts reclassified from AOCI | — | | | — | | | — | |
| Net change | $ | (114) | | | $ | 28 | | | $ | (86) | |
| Cash Flow Hedges | | | | | |
| | | | | |
| Amounts reclassified from AOCI | $ | 2 | | | $ | — | | | $ | 2 | |
| Net change | $ | 2 | | | $ | — | | | $ | 2 | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
9. Income Taxes
The following table presents the calculation of the Company's effective income tax rate (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | |
| | For the Three Months Ended June 30, | | For the Six Months Ended June 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
| Income before income taxes | $ | 1,452 | | | $ | 2,222 | | | $ | 3,070 | | | $ | 4,301 | |
| Income tax expense | $ | 341 | | | $ | 524 | | | $ | 717 | | | $ | 1,010 | |
| Effective income tax rate | 23.5 | % | | 23.6 | % | | 23.4 | % | | 23.5 | % |
| | | | | | | |
Income tax expense decreased $183 million and $293 million for the three and six months ended June 30, 2022, respectively, as compared to the same periods in 2021 due to a decrease in pretax income. The effective tax rate was relatively flat for the three and six months ended June 30, 2022, as compared to the same periods in 2021.
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 filing. The Company regularly assesses the likelihood of additional assessments or settlements in each of the taxing jurisdictions. At this time, the potential change in unrecognized tax benefits is expected to be immaterial over the next 12 months. The Company believes that its reserves are sufficient to cover any tax, penalties and interest that would result from such examinations.
10. Earnings Per Share
The following table presents the calculation of basic and diluted earnings per share ("EPS") (dollars and shares in millions, except per share amounts): | | | | | | | | | | | | | | | | | | | | | | | |
| | For the Three Months Ended June 30, | | For the Six Months Ended June 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
| Numerator | | | | | | | |
| Net income | $ | 1,111 | | | $ | 1,698 | | | $ | 2,353 | | | $ | 3,291 | |
| Preferred stock dividends | — | | | — | | | (31) | | | (39) | |
| Net income available to common stockholders | 1,111 | | | 1,698 | | | 2,322 | | | 3,252 | |
| Income allocated to participating securities | (6) | | | (10) | | | (13) | | | (18) | |
| Net income allocated to common stockholders | $ | 1,105 | | | $ | 1,688 | | | $ | 2,309 | | | $ | 3,234 | |
| Denominator | | | | | | | |
| Weighted-average shares of common stock outstanding | 279 | | | 304 | | | 282 | | | 305 | |
| Effect of dilutive common stock equivalents | — | | | — | | | — | | | — | |
| Weighted-average shares of common stock outstanding and common stock equivalents | 279 | | | 304 | | | 282 | | | 305 | |
| | | | | | | |
| Basic earnings per common share | $ | 3.96 | | | $ | 5.56 | | | $ | 8.19 | | | $ | 10.60 | |
| Diluted earnings per common share | $ | 3.96 | | | $ | 5.55 | | | $ | 8.18 | | | $ | 10.59 | |
| | | | | | | |
Anti-dilutive securities were not material and had no impact on the computation of diluted EPS for the three or six months ended June 30, 2022 and 2021.
11. 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 Federal Deposit Insurance Corporation ("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 2020, 2021 and 2022 are higher than they otherwise would have been. The Company's CET1 capital ratios will continue to be favorably impacted by this election over the phase-in period.
As of June 30, 2022 and December 31, 2021, 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) |
| June 30, 2022 | | | | | | | | | | | |
| Total capital (to risk-weighted assets) | | | | | | | | | | | |
| Discover Financial Services | $ | 17,165 | | | 17.0 | % | | $ | 8,078 | | | ≥8.0% | | $ | 10,098 | | | ≥10.0% |
| Discover Bank | $ | 15,622 | | | 15.6 | % | | $ | 8,004 | | | ≥8.0% | | $ | 10,005 | | | ≥10.0% |
| Tier 1 capital (to risk-weighted assets) | | | | | | | | | | | |
| Discover Financial Services | $ | 15,370 | | | 15.2 | % | | $ | 6,059 | | | ≥6.0% | | $ | 6,059 | | | ≥6.0% |
| Discover Bank | $ | 13,639 | | | 13.6 | % | | $ | 6,003 | | | ≥6.0% | | $ | 8,004 | | | ≥8.0% |
| Tier 1 capital (to average assets) | | | | | | | | | | | |
| Discover Financial Services | $ | 15,370 | | | 13.9 | % | | $ | 4,432 | | | ≥4.0% | | N/A | | N/A |
| Discover Bank | $ | 13,639 | | | 12.4 | % | | $ | 4,385 | | | ≥4.0% | | $ | 5,481 | | | ≥5.0% |
| Common Equity Tier 1 (to risk-weighted assets) | | | | | | | | | | | |
| Discover Financial Services | $ | 14,315 | | | 14.2 | % | | $ | 4,544 | | | ≥4.5% | | N/A | | N/A |
| Discover Bank | $ | 13,639 | | | 13.6 | % | | $ | 4,502 | | | ≥4.5% | | $ | 6,503 | | | ≥6.5% |
| | | | | | | | | | | |
| 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% |
| | | | | | | | | | | |
(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.
12. 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 June 30, 2022, the Company had unused credit arrangements for loans of approximately $223.3 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 2: Investments for a description of contingent liabilities related to the Company's community reinvestment initiatives. See Note 13: Litigation and Regulatory Matters for a description of potential liability arising from pending litigation or regulatory proceedings involving the Company.
Guarantees
The Company has obligations under certain guarantee arrangements, including contracts, indemnification agreements and representations and warranties, which contingently require the Company to make payments to the guaranteed party based on changes in an underlying asset, liability or equity security of a guaranteed party, rate or index. Also included as guarantees are contracts that contingently require the Company to make payments to a guaranteed party based on another entity's failure to perform under an agreement. The Company's use of guarantees is disclosed below by type of guarantee.
Securitizations Representations and Warranties
As part of the Company's financing activities, the Company provides representations and warranties that certain assets pledged as collateral in secured borrowing arrangements conform to specified guidelines. Due diligence is performed by the Company, which is intended to ensure that asset guideline qualifications are met. If the assets pledged as collateral do not meet certain conforming guidelines, the Company may be required to replace, repurchase or sell such assets. In its credit card securitization activities, the Company would replace nonconforming receivables through the allocation of excess seller's interest or from additional transfers from the unrestricted pool of receivables. If the Company could not add enough receivables to satisfy the requirement, an early amortization (or repayment) of investors' interests would be triggered. In its student loan securitizations, the Company would generally repurchase the loans from the trust at the outstanding principal amount plus interest.
The maximum potential amount of future payments the Company could be required to make would be equal to the current outstanding balances of third-party investor interests in credit card asset-backed securities and the principal amount of any private student loan secured borrowings, plus any unpaid interest for the corresponding secured borrowings. The Company has recorded substantially all of the maximum potential amount of future payments in long-term borrowings on the Company's condensed consolidated statements of financial condition. The Company has not recorded any incremental contingent liability associated with its secured borrowing representations and warranties. Management believes that the probability of having to replace, repurchase or sell assets pledged as collateral under secured borrowing arrangements, including an early amortization event, is low.
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 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 $100 million as of June 30, 2022.
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 June 30, 2022, the Company had not recorded any contingent liability in the condensed consolidated financial statements for these counterparty exposures and management believes that the probability of any payments under these arrangements is low.
Discover Network Merchant Chargeback Guarantees
The Company operates the Discover Network, issues payment cards and permits third parties to issue payment cards. The Company is contingently liable for certain transactions processed on the Discover Network in the event of a dispute between the payment card customer and a merchant. The contingent liability arises if the disputed transaction involves a merchant or merchant acquirer with whom the Discover Network has a direct relationship. If a dispute is resolved in the customer's favor, the Discover Network will credit or refund the disputed amount to the Discover Network card issuer, who in turn credits its customer's account. The Discover Network will then charge back the disputed amount of the payment card transaction to the merchant or merchant acquirer, where permitted by the applicable agreement, to seek recovery of amounts already paid to the merchant for payment card transactions. If the Discover Network is unable to collect the amount subject to dispute from the merchant or merchant acquirer (e.g., in the event of merchant default or dissolution or after expiration of the time period for chargebacks in the applicable agreement), the Discover Network will bear the loss for the amount credited or refunded to the customer. In most instances, a loss by the Discover Network is unlikely to arise in connection with payments on card transactions because most products or services are delivered when purchased and credits are issued by merchants on returned items in a timely fashion, thus minimizing the likelihood of cardholder disputes with respect to amounts paid by the Discover Network. However, where the product or service is not scheduled to be provided to the customer until a later date following the purchase, the likelihood of a contingent payment obligation by the Discover Network increases. Losses related to merchant chargebacks were not material for the three and six months ended June 30, 2022 and 2021.
The maximum potential amount of obligations of the Discover Network arising from such contingent obligations is estimated to be the portion of the total Discover Network transaction volume processed to date for which timely and valid disputes may be raised under applicable law and relevant issuer and customer agreements. There is no limitation on the maximum amount the Company may be liable to pay to issuers. However, the Company believes that such amount is not representative of the Company's actual potential loss exposure based on the Company's historical experience. The actual amount of the potential exposure cannot be quantified as the Company cannot determine whether the current or cumulative transaction volumes may include or result in disputed transactions.
The following table summarizes certain information regarding merchant chargeback guarantees (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | |
| | For the Three Months Ended June 30, | | For the Six Months Ended June 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
Aggregate sales transaction volume(1) | $ | 65,586 | | | $ | 55,123 | | | $ | 122,739 | | | $ | 102,610 | |
| | | | | | | |
(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 condensed consolidated financial statements for merchant chargeback guarantees as of June 30, 2022 and December 31, 2021. The Company mitigates the risk of potential loss exposure by withholding settlement from merchants, obtaining third-party guarantees, or obtaining escrow deposits or letters of credit from certain merchant acquirers or merchants that are considered a higher risk due to various factors such as time delays in the delivery of products or services. As of June 30, 2022 and December 31, 2021, the Company had escrow deposits and settlement withholdings of $11 million and $15 million, respectively, which are recorded in interest-bearing deposit accounts and accrued expenses and other liabilities on the Company's condensed consolidated statements of financial condition.
13. 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 condensed consolidated financial statements, increase its cost of operations, or limit the Company's ability to execute its business strategies and engage in certain business activities. Certain subsidiaries of the Company are subject to 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 expenses were immaterial for the three and six months ended June 30, 2022 and 2021.
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 $190 million as of June 30, 2022. This estimated range of reasonably possible losses is based on currently available information for those proceedings in which the Company is involved and considers the Company's best estimate of such losses for those matters for which an estimate can be made. It does not represent the Company's maximum potential loss exposure. Various aspects of the legal proceedings underlying the estimated range will change from time to time and actual results may vary significantly from the estimate.
The Company's estimated range noted above involves significant judgment, given the varying stages of the proceedings, the existence of numerous yet to be resolved issues, the breadth of the claims (often spanning multiple years and, in some cases, a wide range of business activities), unspecified damages and/or the novelty of the legal issues presented. The outcome of pending matters could adversely affect the Company's reputation and be material to the Company's condensed consolidated financial condition, operating results and cash flows for a particular future period, depending on, among other things, the level of the Company's income for such period.
In July 2015, the Company announced that its subsidiaries, Discover Bank, The Student Loan Corporation and Discover Products Inc. (the "Discover Subsidiaries"), agreed to a consent order with the CFPB with respect to certain private student loan servicing practices (the “2015 Order”). The 2015 Order expired in July 2020. 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 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. Expert discovery closed on February 28, 2022. On June 3, 2022, the Court granted Plaintiffs' Motion to Approve Class Notices. 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.
14. 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. Accounting Standards Codification ("ASC") Topic 820, Fair Value Measurement, provides a three-level hierarchy for classifying the inputs to valuation techniques used to measure fair value of financial instruments based on whether the inputs are observable or unobservable. It also requires certain disclosures about those measurements. The three-level valuation hierarchy is as follows:
•Level 1: Fair values determined by Level 1 inputs are defined as those that utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access.
•Level 2: Fair values determined by Level 2 inputs are those that utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active or inactive markets, quoted prices for the identical assets in an inactive market and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. The Company evaluates factors such as the frequency of transactions, the size of the bid-ask spread and the significance of adjustments made when considering transactions involving similar assets or liabilities to assess the relevance of those observed prices. If relevant and observable prices are available, the fair values of the related assets or liabilities would be classified as Level 2.
•Level 3: Fair values determined by Level 3 inputs are those based on unobservable inputs and include situations where there is little, if any, market activity for the asset or liability being valued. In instances where the inputs used to measure fair value may fall into different levels of the fair value hierarchy, the level in the fair value hierarchy in which the measurements classified 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 June 30, 2022 | | | | | | | |
| Assets | | | | | | | |
| Fair value - OCI | | | | | | | |
| U.S. Treasury and U.S. GSE securities | $ | 5,178 | | | $ | 8 | | | $ | — | | | $ | 5,186 | |
| Residential mortgage-backed securities - Agency | — | | | 142 | | | — | | | 142 | |
| Available-for-sale investment securities | $ | 5,178 | | | $ | 150 | | | $ | — | | | $ | 5,328 | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| Fair value - Net income | | | | | | | |
| Marketable equity securities | $ | 95 | | | $ | — | | | $ | — | | | $ | 95 | |
Derivative financial instruments - fair value hedges(1) | $ | — | | | $ | 1 | | | $ | — | | | $ | 1 | |
| | | | | | | |
| | | | | | | |
| Liabilities | | | | | | | |
| Fair value - OCI | | | | | | | |
Derivative financial instruments - cash flow hedges(1) | $ | — | | | $ | 4 | | | $ | — | | | $ | 4 | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| 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 | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| Fair value - Net income | | | | | | | |
| | | | | | | |
| | | | | | | |
| Marketable equity securities | $ | 461 | | | $ | — | | | $ | — | | | $ | 461 | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
. (1)Derivative instrument carrying values in an asset or liability position are presented as part of other assets or accrued expenses and other liabilities, respectively, in the Company's condensed consolidated statements of financial condition.
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 June 30, 2022, 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 $144 million, a weighted-average coupon of 3.23% 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 by comparing the contracted forward exchange rate pertaining to the specific contract maturities to the current market exchange rate.
The Company validates the fair value estimates of interest rate swaps primarily through comparison to the fair value estimates computed by the counterparties to each of the derivative transactions. The Company evaluates pricing variances among different pricing sources to ensure that the valuations utilized are reasonable. The Company also corroborates the reasonableness of the fair value estimates with analysis of trends of significant inputs, such as market interest rate curves. The Company performs due diligence in understanding the impact of any changes to the valuation techniques performed by proprietary pricing models before implementation, working closely with the third-party valuation service and reviewing the service's control objectives at least annually. The Company corroborates the fair value of foreign exchange forward contracts through independent calculation of the fair value estimates.
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 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. 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. No impairments were recognized related to these assets during the three and six months ended June 30, 2022. The Company recognized $92 million of impairments related to these assets during the three and six months ended June 30, 2021.
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 June 30, 2022 | 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 | $ | — | | | $ | 194 | | | $ | — | | | $ | 194 | | | $ | 208 | |
| Held-to-maturity investment securities | $ | — | | | $ | 194 | | | $ | — | | | $ | 194 | | | $ | 208 | |
| | | | | | | | | |
| Net loan receivables | $ | — | | | $ | — | | | $ | 99,405 | | | $ | 99,405 | | | $ | 92,544 | |
| | | | | | | | | |
Carrying value approximates fair value(1) | | | | | | | | | |
| Cash and cash equivalents | $ | 11,439 | | | $ | — | | | $ | — | | | $ | 11,439 | | | $ | 11,439 | |
| Restricted cash | $ | 32 | | | $ | — | | | $ | — | | | $ | 32 | | | $ | 32 | |
| | | | | | | | | |
Accrued interest receivables(2) | $ | — | | | $ | 979 | | | $ | — | | | $ | 979 | | | $ | 979 | |
| | | | | | | | | |
| Liabilities | | | | | | | | | |
| Amortized cost | | | | | | | | | |
Time deposits(3) | $ | — | | | $ | 22,871 | | | $ | — | | | $ | 22,871 | | | $ | 22,958 | |
| Short-term borrowings | $ | — | | | $ | 1,800 | | | $ | — | | | $ | 1,800 | | | $ | 1,800 | |
| | | | | | | | | |
| Long-term borrowings - owed to securitization investors | $ | — | | | $ | 8,854 | | | $ | 93 | | | $ | 8,947 | | | $ | 9,099 | |
| Other long-term borrowings | — | | | 8,829 | | | — | | | 8,829 | | | 9,086 | |
| Long-term borrowings | $ | — | | | $ | 17,683 | | | $ | 93 | | | $ | 17,776 | | | $ | 18,185 | |
| | | | | | | | | |
Carrying value approximates fair value(1) | | | | | | | | | |
Accrued interest payables(2) | $ | — | | | $ | 187 | | | $ | — | | | $ | 187 | | | $ | 187 | |
| | | | | | | | | |
| | | | | | | | | |
| Balance at December 31, 2021 | | | | | | | | | |
| Assets | | | | | | | | | |
| Amortized cost | | | | | | | | | |
| Residential mortgage-backed securities - Agency | $ | — | | | $ | 206 | | | $ | — | | | $ | 206 | | | $ | 204 | |
| Held-to-maturity investment securities | $ | — | | | $ | 206 | | | $ | — | | | $ | 206 | | | $ | 204 | |
| | | | | | | | | |
| Net loan receivables | $ | — | | | $ | — | | | $ | 94,176 | | | $ | 94,176 | | | $ | 86,862 | |
| | | | | | | | | |
Carrying value approximates fair value(1) | | | | | | | | | |
| Cash and cash equivalents | $ | 8,750 | | | $ | — | | | $ | — | | | $ | 8,750 | | | $ | 8,750 | |
| Restricted cash | $ | 2,582 | | | $ | — | | | $ | — | | | $ | 2,582 | | | $ | 2,582 | |
| | | | | | | | | |
Accrued interest receivables(2) | $ | — | | | $ | 948 | | | $ | — | | | $ | 948 | | | $ | 948 | |
| | | | | | | | | |
| Liabilities | | | | | | | | | |
| Amortized cost | | | | | | | | | |
Time deposits(3) | $ | — | | | $ | 21,490 | | | $ | — | | | $ | 21,490 | | | $ | 21,125 | |
| Short-term borrowings | $ | — | | | $ | 1,750 | | | $ | — | | | $ | 1,750 | | | $ | 1,750 | |
| | | | | | | | | |
| 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 | |
| | | | | | | | | |
Carrying value approximates fair value(1) | | | | | | | | | |
Accrued interest payables(2) | $ | — | | | $ | 184 | | | $ | — | | | $ | 184 | | | $ | 184 | |
| | | | | | | | | |
(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 condensed consolidated statements of financial condition.
(3)Excludes deposits without contractually defined maturities for all periods presented.
15. 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 14: Fair Value Measurements for a description of the valuation methodologies used for derivatives. Cash collateral amounts associated with derivative positions that are cleared through an exchange are legally characterized as settlement of the derivative positions. Such collateral amounts are reflected as offsets to the associated derivatives balances recorded in other assets or in accrued expenses and other liabilities. Other cash collateral posted and held balances are recorded in other assets and deposits, respectively, in the condensed consolidated statements of financial condition. Collateral amounts recorded in the condensed consolidated statements of financial condition are based on the net collateral posted or held position for each applicable legal entity's master netting arrangement with each counterparty.
Derivatives Designated as Hedges
Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows arising from changes in interest rates, or other types of forecasted transactions, are considered cash flow hedges. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges.
Cash Flow Hedges
The Company uses interest rate swaps to manage its exposure to variability in cash flows related to changes in interest rates on interest-earning assets and funding instruments. These interest rate swaps qualify for hedge accounting in accordance with ASC Topic 815, Derivatives and Hedging ("ASC 815"). At June 30, 2022 and December 31, 2021, 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 June 30, 2022, 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. At June 30, 2022 and December 31, 2021, the Company used 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 the Federal Funds OIS rate, which is a benchmark interest rate defined by ASC 815. At December 31, 2021, the Company also used an interest rate swap to manage its exposure to changes in fair value of certain securitized debt attributable to changes in the 1-month LIBOR rate, which is a benchmark interest rate 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 on the condensed consolidated statements of income.
Derivatives Cleared Through an Exchange
Cash variation margin payments on derivatives cleared through an exchange are legally considered settlement payments and are accounted for with corresponding derivative positions as one unit of account and not presented separately as collateral. With settlement payments on derivative positions cleared through this exchange reflected as offsets to the associated derivative asset and liability balances, the fair values of derivative instruments and collateral balances shown are generally reduced.
Derivatives Activity
The following table summarizes the fair value (including accrued interest) and outstanding notional amounts of derivative instruments and related collateral balances (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | June 30, 2022 | | December 31, 2021 |
| | Notional
Amount | | Number of Outstanding Derivative Contracts | | Derivative Assets | | Derivative Liabilities | | Notional
Amount | | Derivative Assets(1) | | Derivative Liabilities(1) |
| Derivatives designated as hedges | | | | | | | | | | | | | |
Interest rate swaps—cash flow hedge(2) | $ | 750 | | | 2 | | | $ | — | | | $ | 4 | | | $ | 250 | | | $ | — | | | $ | — | |
| Interest rate swaps—fair value hedge | $ | 3,425 | | | 4 | | | 1 | | | — | | | $ | 6,125 | | | — | | | — | |
| Derivatives not designated as hedges | | | | | | | | | | | | | |
Foreign exchange forward contracts(3) | $ | 25 | | | 7 | | | — | | | — | | | $ | 36 | | | — | | | — | |
| | | | | | | | | | | | | |
Total gross derivative assets/liabilities(4) | | | | | 1 | | | 4 | | | | | — | | | — | |
Less: collateral held/posted(5) | | | | | — | | | — | | | | | — | | | — | |
| Total net derivative assets/liabilities | | | | | $ | 1 | | | $ | 4 | | | | | $ | — | | | $ | — | |
| | | | | | | | | | | | | |
(1)The gross and net derivative assets and liabilities were immaterial as of December 31, 2021.
(2)At June 30, 2022, the Company had one forward-starting interest rate swap with a notional amount of $500 million with interest payments set to be exchanged starting in the third quarter of 2022. At December 31, 2021, the Company had no forward-starting interest rate swaps.
(3)The foreign exchange forward contracts have notional amounts of EUR 6 million, GBP 6 million, SGD 1 million, INR 788 million and AUD 1 million as of June 30, 2022, and notional amounts of EUR 6 million, GBP 6 million, SGD 1 million, INR 788 million and AUD 14 million as of December 31, 2021.
(4)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 June 30, 2022 and December 31, 2021, the Company had one outstanding contract with a total notional amount of $23 million and $50 million, respectively, and immaterial fair values.
(5)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): | | | | | | | | | | | | | | | | | | | | | | | |
| June 30, 2022 | | December 31, 2021 |
| Carrying Amount of Hedged Liabilities | | Cumulative Amount of Fair Value Hedging Adjustment Increasing the Carrying Amount of Hedged Liabilities(1) | | Carrying Amount of Hedged Liabilities | | Cumulative Amount of Fair Value Hedging Adjustment Increasing the Carrying Amount of Hedged Liabilities(1) |
| Long-term borrowings | $ | 3,387 | | | $ | 4 | | | $ | 6,158 | | | $ | 83 | |
| | | | | | | |
(1)The balance includes $38 million and $48 million of cumulative hedging adjustments related to discontinued hedging relationships as of June 30, 2022 and December 31, 2021, respectively.
The following table summarizes the impact of the derivative instruments on income and indicates where within the condensed consolidated financial statements such impact is reported (dollars in millions):
| | | | | | | | | | | | | | | |
| | | Location and Amount of (Losses) Gains Recognized on the Condensed Consolidated Statements of Income |
| | | Interest Expense | | | | |
| | | Long-Term Borrowings | | | | Other Income |
| For the Three Months Ended June 30, 2022 | | | | | | | |
| Total amounts of income and expense line items presented in the condensed consolidated statements of income, where the effects of fair value or cash flow hedges are recorded | | | $ | (131) | | | | | $ | 21 | |
| | | | | | | |
| The effects of cash flow and fair value hedging | | | | | | | |
| Losses on cash flow hedging relationship | | | | | | | |
| Amounts reclassified from OCI into earnings | | | $ | (1) | | | | | $ | — | |
| | | | | | | |
| Gains on fair value hedging relationships | | | | | | | |
| Gains on hedged items | | | $ | 22 | | | | | $ | — | |
| Losses on interest rate swaps | | | (18) | | | | | — | |
| Total gains on fair value hedging relationships | | | $ | 4 | | | | | $ | — | |
| | | | | | | |
| The effects of derivatives not designated in hedging relationships | | | | | | | |
| Gains on derivatives not designated as hedges | | | $ | — | | | | | $ | 1 | |
| | | | | | | |
| For the Three Months Ended June 30, 2021 | | | | | | | |
| Total amounts of income and expense line items presented in the condensed consolidated statements of income, where the effects of fair value or cash flow hedges are recorded | | | $ | (120) | | | | | $ | 6 | |
| | | | | | | |
| The effects of cash flow and fair value hedging | | | | | | | |
| Losses on cash flow hedging relationship | | | | | | | |
| Amounts reclassified from OCI into earnings | | | $ | (1) | | | | | $ | — | |
| | | | | | | |
| Gains on fair value hedging relationships | | | | | | | |
| Gains on hedged items | | | $ | 44 | | | | | $ | — | |
| Gains on interest rate swaps | | | 1 | | | | | — | |
| Total gains on fair value hedging relationships | | | $ | 45 | | | | | $ | — | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | | | | | | | | | |
| | | Location and Amount of (Losses) Gains Recognized on the Condensed Consolidated Statements of Income |
| | | Interest Expense | | | | |
| | | Long-Term Borrowings | | | Other Income |
| For the Six Months Ended June 30, 2022 | | | | | | | |
| Total amounts of income and expense line items presented in the condensed consolidated statements of income, where the effects of fair value or cash flow hedges are recorded | | | $ | (248) | | | | | $ | 45 | |
| | | | | | | |
| The effects of cash flow and fair value hedging | | | | | | | |
| Losses on cash flow hedging relationships | | | | | | | |
| Amounts reclassified from OCI into earnings | | | $ | (2) | | | | | $ | — | |
| | | | | | | |
| Gains on fair value hedging relationships | | | | | | | |
| Gains on hedged items | | | $ | 69 | | | | | $ | — | |
| Losses on interest rate swaps | | | (50) | | | | | — | |
| Total gains on fair value hedging relationships | | | $ | 19 | | | | | $ | — | |
| | | | | | | |
| The effects of derivatives not designated in hedging relationships | | | | | | | |
| Gains on derivatives not designated as hedges | | | $ | — | | | | | $ | 1 | |
| | | | | | | |
| For the Six Months Ended June 30, 2021 | | | | | | | |
| Total amounts of income and expense line items presented in the condensed consolidated statements of income, where the effects of fair value or cash flow hedges are recorded | | | $ | (243) | | | | | $ | 29 | |
| | | | | | | |
| The effects of cash flow and fair value hedging | | | | | | | |
| Losses on cash flow hedging relationships | | | | | | | |
| Amounts reclassified from OCI into earnings | | | $ | (2) | | | | | $ | — | |
| | | | | | | |
| Gains on fair value hedging relationships | | | | | | | |
| Gains on hedged items | | | $ | 122 | | | | | $ | — | |
| Losses on interest rate swaps | | | (29) | | | | | — | |
| Total gains on fair value hedging relationships | | | $ | 93 | | | | | $ | — | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
For the impact of the derivative instruments on OCI, see Note 8: Accumulated Other Comprehensive Income.
Collateral Requirements and Credit-Risk Related Contingency Features
The Company has master netting arrangements and minimum collateral posting thresholds with its counterparties for its fair value and cash flow hedge interest rate swaps and foreign exchange forward contracts. The Company has not sought a legal opinion in relation to the enforceability of its master netting arrangements and, as such, does not report any of these positions on a net basis. Collateral is required by either the Company or its subsidiaries or the counterparty depending on the net fair value position of the derivatives held with that counterparty. These collateral receivable or payable amounts are generally not offset against the fair value of these derivatives but are recorded separately in other assets or deposits. Most of the Company's cash collateral amounts relate to positions cleared through an exchange and are reflected as offsets to the associated derivatives balances recorded in other assets and accrued expenses and other liabilities.
The Company also has agreements with certain of its derivative counterparties that contain a provision under which the Company could be declared in default on any of its derivative obligations if the Company defaults on any of its indebtedness, including default where the lender has not accelerated repayment of the indebtedness.
16. 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 Three Months Ended June 30, 2022 | | | | | |
| Interest income | | | | | |
| Credit card loans | $ | 2,424 | | | $ | — | | | $ | 2,424 | |
| Private student loans | 196 | | | — | | | 196 | |
| Personal loans | 206 | | | — | | | 206 | |
| Other loans | 37 | | | — | | | 37 | |
| Other interest income | 52 | | | — | | | 52 | |
| Total interest income | 2,915 | | | — | | | 2,915 | |
| Interest expense | 305 | | | — | | | 305 | |
| Net interest income | 2,610 | | | — | | | 2,610 | |
| Provision for credit losses | 549 | | | — | | | 549 | |
| Other income | 557 | | | 57 | | | 614 | |
| Other expense | 1,186 | | | 37 | | | 1,223 | |
| Income before income taxes | $ | 1,432 | | | $ | 20 | | | $ | 1,452 | |
| | | | | |
| For the Three Months Ended June 30, 2021 | | | | | |
| Interest income | | | | | |
| Credit card loans | $ | 2,105 | | | $ | — | | | $ | 2,105 | |
| Private student loans | 184 | | | — | | | 184 | |
| Personal loans | 219 | | | — | | | 219 | |
| Other loans | 28 | | | — | | | 28 | |
| Other interest income | 53 | | | — | | | 53 | |
| Total interest income | 2,589 | | | — | | | 2,589 | |
| Interest expense | 290 | | | — | | | 290 | |
| Net interest income | 2,299 | | | — | | | 2,299 | |
| Provision for credit losses | 135 | | | — | | | 135 | |
| Other income | 458 | | | 822 | | | 1,280 | |
| Other expense | 1,092 | | | 130 | | | 1,222 | |
| Income before income taxes | $ | 1,530 | | | $ | 692 | | | $ | 2,222 | |
| | | | | |
| | | | | | | | | | | | | | | | | |
| Digital
Banking | | Payment
Services | | Total |
| For the Six Months Ended June 30, 2022 | | | | | |
| Interest income | | | | | |
| Credit card loans | $ | 4,692 | | | $ | — | | | $ | 4,692 | |
| Private student loans | 386 | | | — | | | 386 | |
| Personal loans | 412 | | | — | | | 412 | |
| Other loans | 69 | | | — | | | 69 | |
| Other interest income | 92 | | | — | | | 92 | |
| Total interest income | 5,651 | | | — | | | 5,651 | |
| Interest expense | 562 | | | — | | | 562 | |
| Net interest income | 5,089 | | | — | | | 5,089 | |
| Provision for credit losses | 703 | | | — | | | 703 | |
| Other income (loss) | 1,043 | | | (6) | | | 1,037 | |
| Other expense | 2,278 | | | 75 | | | 2,353 | |
| Income (loss) before income tax expense | $ | 3,151 | | | $ | (81) | | | $ | 3,070 | |
| | | | | |
| For the Six Months Ended June 30, 2021 | | | | | |
| Interest income | | | | | |
| Credit card loans | $ | 4,259 | | | $ | — | | | $ | 4,259 | |
| Private student loans | 370 | | | — | | | 370 | |
| Personal loans | 442 | | | — | | | 442 | |
| Other loans | 56 | | | — | | | 56 | |
| Other interest income | 108 | | | — | | | 108 | |
| Total interest income | 5,235 | | | — | | | 5,235 | |
| Interest expense | 606 | | | — | | | 606 | |
| Net interest income | 4,629 | | | — | | | 4,629 | |
| Provision for credit losses | (230) | | | — | | | (230) | |
| Other income | 837 | | | 908 | | | 1,745 | |
| Other expense | 2,139 | | | 164 | | | 2,303 | |
| Income before income tax expense | $ | 3,557 | | | $ | 744 | | | $ | 4,301 | |
| | | | | |
17. 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 certain 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 Three Months Ended June 30, 2022 | | | | | |
| Other income subject to ASC 606 | | | | | |
Discount and interchange revenue, net(1) | $ | 370 | | | $ | 20 | | | $ | 390 | |
| Protection products revenue | 42 | | | — | | | 42 | |
| Transaction processing revenue | — | | | 61 | | | 61 | |
| Other income | 3 | | | 18 | | | 21 | |
Total other income subject to ASC 606(2) | 415 | | | 99 | | | 514 | |
| Other income not subject to ASC 606 | | | | | |
| Loan fee income | 142 | | | — | | | 142 | |
| Unrealized gains (losses) on equity investments | — | | | (169) | | | (169) | |
| Realized gains on equity investments | — | | | 127 | | | 127 | |
| Total other income (loss) not subject to ASC 606 | 142 | | | (42) | | | 100 | |
| Total other income (loss) by operating segment | $ | 557 | | | $ | 57 | | | $ | 614 | |
| | | | | |
| For the Three Months Ended June 30, 2021 | | | | | |
| Other income subject to ASC 606 | | | | | |
Discount and interchange revenue, net(1) | $ | 320 | | | $ | 19 | | | $ | 339 | |
| Protection products revenue | 43 | | | — | | | 43 | |
| Transaction processing revenue | — | | | 58 | | | 58 | |
| Other (loss) income | (10) | | | 16 | | | 6 | |
Total other income subject to ASC 606(2) | 353 | | | 93 | | | 446 | |
| Other income not subject to ASC 606 | | | | | |
| Loan fee income | 105 | | | — | | | 105 | |
| Unrealized gains on equity investments | — | | | 729 | | | 729 | |
| | | | | |
| Total other income not subject to ASC 606 | 105 | | | 729 | | | 834 | |
| Total other income by operating segment | $ | 458 | | | $ | 822 | | | $ | 1,280 | |
| | | | | |
| | | | | |
| | | | | | | | | | | | | | | | | |
| Digital Banking | | Payment Services | | Total |
| For the Six Months Ended June 30, 2022 | | | | | |
| Other income subject to ASC 606 | | | | | |
Discount and interchange revenue, net(1) | $ | 668 | | | $ | 42 | | | $ | 710 | |
| Protection products revenue | 86 | | | — | | | 86 | |
| Transaction processing revenue | — | | | 118 | | | 118 | |
| Other income | 6 | | | 39 | | | 45 | |
Total other income subject to ASC 606(2) | 760 | | | 199 | | | 959 | |
| Other income not subject to ASC 606 | | | | | |
| Loan fee income | 282 | | | — | | | 282 | |
| Unrealized gains (losses) on equity investments | — | | | (357) | | | (357) | |
| Realized gains on equity investments | 1 | | | 152 | | | 153 | |
| Total other income (loss) not subject to ASC 606 | 283 | | | (205) | | | 78 | |
| Total other income (loss) by operating segment | $ | 1,043 | | | $ | (6) | | | $ | 1,037 | |
| | | | | |
| For the Six Months Ended June 30, 2021 | | | | | |
| Other income subject to ASC 606 | | | | | |
Discount and interchange revenue, net(1) | $ | 546 | | | $ | 34 | | | $ | 580 | |
| Protection products revenue | 86 | | | — | | | 86 | |
| Transaction processing revenue | — | | | 109 | | | 109 | |
| Other (loss) income | (7) | | | 36 | | | 29 | |
Total other income subject to ASC 606(2) | 625 | | | 179 | | | 804 | |
| Other income not subject to ASC 606 | | | | | |
| Loan fee income | 212 | | | — | | | 212 | |
| Unrealized gains on equity investments | — | | | 729 | | | 729 | |
| | | | | |
| Total other income not subject to ASC 606 | 212 | | | 729 | | | 941 | |
| Total other income by operating segment | $ | 837 | | | $ | 908 | | | $ | 1,745 | |
| | | | | |
(1)Net of rewards, including Cashback Bonus rewards, of $743 million and $598 million for the three months ended June 30, 2022 and 2021, respectively, and $1.4 billion and $1.1 billion for the six months ended June 30, 2022 and 2021, respectively.
(2)Excludes deposit product fees that are reported within net interest income, which were immaterial for the three and six months ended June 30, 2022 and 2021, respectively.
For a detailed description of the Company's significant revenue recognition accounting policies, see Note 2: Summary of Significant Accounting Policies to the consolidated financial statements in the Company's annual report on Form 10-K for the year ended December 31, 2021.
18. Subsequent Events
The Company has evaluated events and transactions that have occurred subsequent to June 30, 2022, and determined that there were no subsequent events that would require recognition or disclosure in the condensed consolidated financial statements.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this quarterly report. This quarterly report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements, which speak to our expected business and financial performance, among other matters, contain words such as "believe," "expect," "anticipate," "intend," "plan," "aim," "will," "may," "should," "could," "would," "likely," "forecast," and similar expressions. Such statements are based on the current beliefs and expectations of our management and are subject to significant risks and uncertainties. Actual results may differ materially from those set forth in the forward-looking statements. These forward-looking statements speak only as of the date of this quarterly report and there is no undertaking to update or revise them as more information becomes available.
The following factors, among others, could cause actual results to differ materially from those set forth in the forward-looking statements: the effect of the coronavirus disease 2019 ("COVID-19") pandemic and measures taken to mitigate the pandemic, including their impact on our credit quality and business operations as well as their impact on general economic and financial markets, changes in economic variables, such as the availability of consumer credit, the housing market, energy costs, the number and size of personal bankruptcy filings, the rate of unemployment, the levels of consumer confidence and consumer debt and investor sentiment; the impact of current, pending and future legislation, regulation, supervisory guidance and regulatory and legal actions, including, but not limited to, those related to financial regulatory reform, consumer financial services practices, anti-corruption and funding, capital and liquidity; the actions and initiatives of current and potential competitors; our ability to manage our expenses; our ability to successfully achieve card acceptance across our networks and maintain relationships with network participants; our ability to sustain and grow our private student loan, personal loan and home loan products; difficulty obtaining regulatory approval for, financing, transitioning, integrating or managing the expenses of acquisitions of or investments in new businesses, products or technologies; our ability to manage our credit risk, market risk, liquidity risk, operational risk, legal and compliance risk and strategic risk; the availability and cost of funding and capital; access to deposit, securitization, equity, debt and credit markets; the impact of rating agency actions; the level and volatility of equity prices, commodity prices and interest rates, currency values, investments, other market fluctuations and other market indices; losses in our investment portfolio; limits on our ability to pay dividends and repurchase our common stock; limits on our ability to receive payments from our subsidiaries; fraudulent activities or material security breaches of key systems; our ability to remain organizationally effective; our ability to increase or sustain Discover card usage or attract new customers; our ability to maintain relationships with merchants; the effect of political, economic and market conditions, geopolitical events and unforeseen or catastrophic events; our ability to introduce new products and services; our ability to manage our relationships with third-party vendors; our ability to maintain current technology and integrate new and acquired systems; our ability to collect amounts for disputed transactions from merchants and merchant acquirers; our ability to attract and retain employees; our ability to protect our reputation and our intellectual property; and new lawsuits, investigations or similar matters or unanticipated developments related to current matters. We routinely evaluate and may pursue acquisitions of or investments in businesses, products, technologies, loan portfolios or deposits, which may involve payment in cash or our debt or equity securities.
Additional factors that could cause our results to differ materially from those described below can be found in this section of this quarterly report and in "Risk Factors," "Business," and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our annual report on Form 10-K for the year ended December 31, 2021, which is filed with the Securities and Exchange Commission ("SEC") and available at the SEC's internet site (https://www.sec.gov).
Introduction and Overview
Discover Financial Services ("DFS") is a digital banking and payment services company. We provide digital banking products and services and payment services through our subsidiaries. We offer our customers credit card loans, private student loans, personal loans, home loans and deposit products. We also operate the Discover Network, the PULSE network ("PULSE") and Diners Club International ("Diners Club"), collectively known as the Discover Global Network. The Discover Network processes transactions for Discover-branded credit and debit cards and provides payment transaction processing and settlement services. PULSE operates an electronic funds transfer network, providing financial institutions issuing debit cards on the PULSE network with access to ATMs domestically and internationally and merchant acceptance throughout the United States of America ("U.S.") for debit card transactions. Diners Club is a global payments network of licensees, which are generally financial institutions, that issue Diners Club branded credit and charge cards and/or provide card acceptance services.
Our primary revenues consist of interest income earned on loan receivables and fees earned from customers, financial institutions, merchants and issuers. The primary expenses required to operate our business include funding costs (interest expense), credit loss provisions, customer rewards and expenses incurred to grow, manage and service our loan receivables and networks. Our business activities are funded primarily through consumer deposits, securitization of loan receivables and the issuance of unsecured debt.
COVID-19 Pandemic
All employees are able to work at our physical locations, including our headquarters, with appropriate health and safety measures in place. Separate from our COVID-19 protocols, all employees may request a flexible work arrangement enabling them to work remotely up to 100% of the time.
For a discussion on how the risks related to the COVID-19 pandemic may affect our businesses, results of operations and financial condition, see "Risk Factors" in our annual report on Form 10-K for the year ended December 31, 2021.
Quarter Highlights
The highlights below compare results as of and for the three months ended June 30, 2022, against results for the same period in the prior year.
•Net income was $1.1 billion, or $3.96 per diluted share, compared to net income of $1.7 billion, or $5.55 earnings per diluted share, in the prior year.
•Total loans grew $11.6 billion, or 13%, to $99.3 billion.
•Credit card loans grew $10.4 billion, or 15%, to $79.2 billion.
•The net charge-off rate for credit card loans decreased 44 basis points to 2.01% and the delinquency rate for credit card loans over 30 days past due increased 33 basis points to 1.76%.
•Direct-to-consumer deposits grew $0.6 billion, or 1%, to $63.2 billion.
•Payment Services transaction volume for the segment was $82.9 billion, up 6%.
Outlook
The outlook below provides our current expectations for our financial results based on market conditions, the regulatory and legal environment and our business strategies.
•We expect elevated loan growth based on the current expectations of sales trends and recent account growth.
•Based on the current interest rate environment, net interest margin is expected to increase modestly in comparison to 2021, with some variability from quarter to quarter.
•We expect a slight increase in the total net charge-off rate as credit continues to normalize from historically low levels in 2021.
•We remain committed to managing expenses and will continue to make investments for profitable long term growth.
Regulatory Environment and Developments
Banking
Capital Standards and Stress Testing
As a bank holding company, DFS is subject to mandatory supervisory stress tests every other year and is required to submit annual capital plans to the Federal Reserve based on forward-looking internal analysis of income and capital levels under expected and stressful conditions. DFS is also subject to capital buffer requirements, including the Stress Capital Buffer ("SCB"), which requires maintenance of regulatory capital levels above a threshold established based on the results of supervisory stress tests after accounting for planned dividend payments.
In January 2021, the Federal Reserve finalized regulatory amendments that made targeted changes to the capital planning, regulatory reporting and SCB requirements for firms subject to Category IV standards, including DFS, to be consistent with the Federal Reserve’s regulatory tailoring framework. The final rules generally align to instructions the Federal Reserve previously provided to Category IV firms regarding their respective capital plan submissions. The amended rules also provide Category IV firms with the option to submit to supervisory stress tests during off years if they wish for the Federal Reserve to reset the stress test portion of their SCB requirement. In connection with the final rulemaking, the Federal Reserve revised the scope of application of its existing regulatory guidance for capital planning to align with the tailoring framework. However, the timing and substance of any additional changes to existing guidance or new guidance are uncertain.
In June 2021, the Federal Reserve publicly announced the results of its supervisory stress tests for the firms required to participate in the 2021 comprehensive capital analysis and review ("CCAR") process. In accordance with the capital plan rule amendments that were finalized in January 2021, DFS elected not to participate in the 2021 supervisory stress tests. Nevertheless, DFS was required to submit a capital plan based on a forward-looking internal assessment of income and capital under baseline and stressful conditions. The Federal Reserve thereafter used our 2021 capital plan submission to assess its capital planning process and positions and, in August 2021, announced DFS' adjusted SCB requirement of 3.6% to reflect DFS' planned common stock dividends. This adjusted SCB is effective through October 1, 2022. Discover was a full participant in the 2022 CCAR process and submitted the 2022 Capital Plan to the Federal Reserve by the April 5, 2022 due date.
On June 23, 2022, the Federal Reserve released results of the 2022 CCAR exercise. Discover’s results showed strong capital levels under stress, well above regulatory minimums. These results will be used to set the new SCB effective October 1, 2022. While the Federal Reserve will not announce final SCB requirements until August, Discover’s preliminary SCB is 2.5%, the lowest possible requirement.
London Interbank Offered Rate
In July 2017, the UK Financial Conduct Authority ("FCA") announced that it would no longer encourage or compel banks to continue to contribute quotes and maintain the London Interbank Offered Rate ("LIBOR") after 2021. To support a smooth transition away from LIBOR, the Federal Reserve and the Federal Reserve Bank of New York convened the Alternative Reference Rates Committee ("ARRC"), a group of private-market participants tasked with facilitating a successful transition from U.S. dollar ("USD") LIBOR to a more robust reference rate. The ARRC initially identified the Secured Overnight Financing Rate ("SOFR") as its recommended alternative reference rate for USD LIBOR. The ARRC has also established several priorities and milestones to support the use of SOFR and SOFR-based indices, including developing contractual "fallback" language for capital markets and consumer products; providing clarity on legal, tax, accounting and regulatory matters; promoting broad outreach and education efforts around the LIBOR transition; and recommending spread adjustments for SOFR and SOFR-based indices, which will be of critical importance to market participants once USD LIBOR settings cease in 2023.
With regard to recent LIBOR transition developments, in March 2021, the FCA announced the future cessation and loss of representativeness for all LIBOR benchmark settings. While non-USD and several less frequently referenced USD LIBOR settings ceased publication immediately after December 31, 2021, commonly referenced USD LIBOR settings will cease publication immediately after June 30, 2023; this future cessation event will trigger fallback provisions in many financial contracts to convert their benchmark index from LIBOR to an alternative rate. In July 2021, the ARRC announced its recommendation of forward-looking term rates based on SOFR as additional alternative reference rate options.
In December 2021, the Consumer Financial Protection Bureau ("CFPB") finalized a rule to facilitate transition from LIBOR, which is effective April 1, 2022. Specifically, this final rule provides guidance on LIBOR replacements and the LIBOR transition for purposes of Regulation Z. We have communicated with the CFPB regarding our plans for the LIBOR transition.
A cross-functional team is overseeing and managing our transition away from the use of LIBOR. This team assesses evolving industry and marketplace norms and conventions for LIBOR-indexed instruments, evaluates the impacts stemming from the future cessation of LIBOR publication and oversees and takes actions to transition our LIBOR exposures to alternative benchmark rates, usually SOFR. Our existing LIBOR exposures are limited to two instruments—variable-rate student loans and capital markets securities.
As of June 30, 2022, LIBOR-indexed variable-rate loans comprised approximately 43% of our private student loan portfolio and approximately 5% of our aggregate loan portfolio. These outstanding student loans indexed to LIBOR will
convert to a SOFR index in 2023 when 3-month USD LIBOR will no longer be published. U.S. banking regulators have directed banks to cease entering into new contracts that use USD LIBOR as a reference rate after December 31, 2021. Therefore, as of November 2021, we no longer originate new variable-rate student loans indexed to LIBOR. Instead, new originations of such loans are indexed solely to 3-month term SOFR published by the Chicago Mercantile Exchange.
We ceased entering into new LIBOR-indexed interest rate derivatives in 2018 and have since actively reduced LIBOR exposures in our derivatives portfolio. During the third quarter of 2021, we terminated our last LIBOR-indexed interest rate swap maturing after June 2023; our one remaining LIBOR-indexed interest rate swap matured in January 2022.
Most of our capital markets securities indexed to USD LIBOR are floating-rate asset-backed securities. Beginning in 2018, we included fallback provisions in all newly issued securities that will facilitate an orderly transition from LIBOR to an appropriate reference rate, which may be based on SOFR, once 1- and 3-month LIBOR cease to be published after June 2023. Approximately $1.5 billion of our capital markets securities that mature after June 2023 with no fallback provisions would be covered under New York LIBOR legislation enacted in April 2021 or federal legislation enacted in March 2022, which preempts the New York LIBOR legislation. This legislation would allow us to replace the LIBOR index with SOFR under a safe harbor provision. Approximately $500 million of our capital markets securities have a rate reset in August 2023 that contains a fallback provision that may not be covered under the New York LIBOR legislation or the federal legislation; however, we may decide to exercise our right to call and redeem those securities on their reset date.
We have prepared for the cessation of USD LIBOR by taking steps to avoid new exposures and actively reduce our remaining exposures. We completed scheduled transition work before year-end 2021, including providing our stakeholders with information about the cessation of USD LIBOR and how it will affect their contracts with us. The transition process will continue through the end of 2023.
Consumer Financial Services
The CFPB regulates consumer financial products and services and examines certain providers of consumer financial products and services, including Discover. The CFPB's authority includes rulemaking, supervisory and enforcement powers with respect to federal consumer protection laws; preventing "unfair, deceptive or abusive acts or practices" ("UDAAP") and ensuring that consumers have access to fair, transparent and competitive financial products and services. Historically, the CFPB's policy priorities focused on several financial products of the type we offer (e.g., credit cards and other consumer lending products). In addition, the CFPB is required by statute to undertake certain actions, including its biennial review of the consumer credit card market.
Under Director Rohit Chopra’s leadership, the CFPB’s priorities have focused on and are expected to continue focusing on, among other things, increased enforcement of existing consumer protection laws, with a particular focus on fees charged to consumers, UDAAP, fair lending, student lending and servicing, debt collection and credit reporting. Additionally, detection of repeat offenders, such as companies that violate a formal court or agency order, has become a top priority for the CFPB. In remarks by Director Chopra in March 2022, he identified, as repeat offenders, several companies that have had multiple enforcement actions, including us. The CFPB has recently taken action against financial institutions for violating prior enforcement actions. Enhanced regulatory requirements, potential supervisory findings, or enforcement actions and ratings could negatively impact our ability to implement certain consumer-focused enhancements to product features and functionality and business strategies, limit or change our business practices, limit our consumer product offerings, cause us to invest more management time and resources in compliance efforts or limit our ability to obtain related required regulatory approvals. The additional expense, time and resources needed to comply with ongoing or new regulatory requirements may adversely impact the cost of and access to credit for consumers and results of business operations.
In December 2020, certain of our subsidiaries entered into a consent order with the CFPB regarding identified private student loan servicing practices. See Note 13: Litigation and Regulatory Matters to our condensed consolidated financial statements for more information.
Data Security and Privacy
Policymakers at the federal and state levels remain focused on enhancing data security and data breach incident response requirements. Furthermore, regulations and legislation at various levels of government have been proposed and enacted to augment consumer data privacy standards. The California Consumer Privacy Act ("CCPA") creates a broad set of privacy rights and remedies modeled in part on the European Union's General Data Protection Regulation. The CCPA went into effect on January 1, 2020, and the California Attorney General's final regulations became effective on August 14, 2020, with enforcement beginning July 1, 2020. The California Privacy Rights Act ("CPRA"), a ballot measure led by the original proponent of the CCPA, passed on November 3, 2020, and largely enters into force on January 1, 2023. The CPRA replaces the CCPA to enhance consumer privacy protections further and creates a new California Privacy Protection Agency ("CPPA"). The CPPA Board released a Notice of Proposed Rulemaking initiating a 45-day comment period, which will close on August 23, 2022. While the CPRA retains an exemption for information collected, processed, sold, or disclosed subject to the Gramm-Leach-Bliley Act, we continue to evaluate the impact of the CPRA on our businesses and other providers of consumer financial services.
Environmental, Social and Governance Matters
Environmental, social and governance ("ESG") issues, including climate change, human capital and governance practices, are a significant area of focus by lawmakers at the state and federal level, regulatory agencies, shareholders and other stakeholders. Proposed legislation and rulemakings have been issued or are being considered, including proposals to require disclosure of climate, cybersecurity and other ESG metrics and risk. The potential impact to us of these legislative and regulatory developments is uncertain at this time.
In particular, in March 2022, the Securities and Exchange Commission proposed climate-related disclosure requirements. Through an enterprise-wide working group, we continue to assess the potential impact of the proposed rules, if adopted.
Segments
We manage our business activities in two segments, Digital Banking and Payment Services, based on the products and services provided. For a detailed description of the operations of each segment, as well as the allocation conventions used in our business segment reporting, see Note 16: Segment Disclosures to our condensed consolidated financial statements.
The following table presents segment data (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | |
| | For the Three Months Ended June 30, | | For the Six Months Ended June 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| Digital Banking | | | | | | | |
| Interest income | | | | | | | |
| Credit card loans | $ | 2,424 | | | $ | 2,105 | | | $ | 4,692 | | | $ | 4,259 | |
| Private student loans | 196 | | | 184 | | | 386 | | | 370 | |
| Personal loans | 206 | | | 219 | | | 412 | | | 442 | |
| Other loans | 37 | | | 28 | | | 69 | | | 56 | |
| Other interest income | 52 | | | 53 | | | 92 | | | 108 | |
| Total interest income | 2,915 | | | 2,589 | | | 5,651 | | | 5,235 | |
| Interest expense | 305 | | | 290 | | | 562 | | | 606 | |
| Net interest income | 2,610 | | | 2,299 | | | 5,089 | | | 4,629 | |
| Provision for credit losses | 549 | | | 135 | | | 703 | | | (230) | |
| Other income | 557 | | | 458 | | | 1,043 | | | 837 | |
| Other expense | 1,186 | | | 1,092 | | | 2,278 | | | 2,139 | |
| Income before income taxes | 1,432 | | | 1,530 | | | 3,151 | | | 3,557 | |
| Payment Services | | | | | | | |
| | | | | | | |
| | | | | | | |
| Other income (loss) | 57 | | | 822 | | | (6) | | | 908 | |
| Other expense | 37 | | | 130 | | | 75 | | | 164 | |
| Income (loss) before income taxes | 20 | | | 692 | | | (81) | | | 744 | |
| Total income before income taxes | $ | 1,452 | | | $ | 2,222 | | | $ | 3,070 | | | $ | 4,301 | |
| | | | | | | |
The following table presents information on transaction volume (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | |
| | For the Three Months Ended June 30, | | For the Six Months Ended June 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
| Network Transaction Volume | | | | | | | |
| PULSE Network | $ | 62,992 | | | $ | 62,855 | | | $ | 122,828 | | | $ | 123,254 | |
| Network Partners | 11,532 | | | 9,468 | | | 22,215 | | | 19,097 | |
Diners Club(1) | 8,381 | | | 6,126 | | | 15,557 | | | 12,023 | |
| Total Payment Services | 82,905 | | | 78,449 | | | 160,600 | | | 154,374 | |
Discover Network — Proprietary(2) | 55,838 | | | 47,201 | | | 103,967 | | | 86,403 | |
| Total Network Transaction Volume | $ | 138,743 | | | $ | 125,650 | | | $ | 264,567 | | | $ | 240,777 | |
| Transactions Processed on Networks | | | | | | | |
| Discover Network | 916 | | | 799 | | | 1,747 | | | 1,477 | |
| PULSE Network | 1,524 | | | 1,399 | | | 2,923 | | | 2,709 | |
| Total Transactions Processed on Networks | 2,440 | | | 2,198 | | | 4,670 | | | 4,186 | |
| Credit Card Volume | | | | | | | |
Discover Card Volume(3) | $ | 57,384 | | | $ | 48,049 | | | $ | 106,763 | | | $ | 88,383 | |
Discover Card Sales Volume(4) | $ | 53,860 | | | $ | 45,460 | | | $ | 100,189 | | | $ | 83,204 | |
| | | | | | | |
(1)Diners Club volume is derived from data provided by licensees for Diners Club branded cards issued outside North America and is subject to subsequent revision or amendment.
(2)Represents gross Discover card sales volume on the Discover Network.
(3)Represents Discover card activity related to sales net of returns, balance transfers, cash advances and other activity.
(4)Represents Discover card activity related to sales net of returns.
Digital Banking
Our Digital Banking segment reported pretax income of $1.4 billion and $3.2 billion, respectively, for the three and six months ended June 30, 2022, as compared to a pretax income of $1.5 billion and $3.6 billion, respectively, for the three and six months ended June 30, 2021.
Net interest income increased for the three and six months ended June 30, 2022, as compared to the same periods in 2021, primarily driven by a higher average level of receivables and higher yields on loans. The increase in net interest income for the six months ended June 30, 2022 was also favorably impacted by lower funding costs. Interest income increased during the three and six months ended June 30, 2022, as compared to the same periods in 2021, due to a higher average level of loan receivables and higher market rates. Interest expense decreased during the six months ended June 30, 2022, as compared to the same period in 2021, due to higher coupon maturities and a lower funding base offset partially by increasing market rates. Interest expense for the three months ended June 30, 2022 was relatively flat, as compared to the same period in 2021, driven by increasing market rates offset primarily by higher coupon maturities.
For the three and six months ended June 30, 2022, the overall portfolio provision for credit losses increased as compared to the same periods in 2021. The increase for the three months ended June 30, 2022, was primarily due to a reserve build in the current period versus a reserve release in the prior period. The reserve build during the three months ended June 30, 2022, was primarily driven by loan growth, partially offset by the continued strength of our portfolio's credit quality. The reserve release for the three months ended June 30, 2021, was primarily driven by improvements in the macroeconomic factors and continued stable credit performance. The increase for the six months ended June 30, 2022, was primarily due to a lower reserve release in the current period compared to the prior period. The reserve release during the six months ended June 30, 2022, was driven by the continued strength of our portfolio's credit quality, partially offset by loan growth. The reserve release during the six months ended June 30, 2021, was primarily driven by improvements in the macroeconomic factors, continued stable performance and a reduction in loan receivables. For a detailed discussion on provision for credit losses, see "— Loan Quality — Provision and Allowance for Credit Losses."
Total other income increased for the three and six months ended June 30, 2022, as compared to the same periods in 2021, which was due to increases in net discount and interchange revenue and loan fee income. The increase in discount and interchange revenue was partially offset by an increase in rewards costs, both of which were the result of higher sales volume. Loan fee income increased primarily due to a higher volume of late payments.
Total other expense increased for the three and six months ended June 30, 2022, as compared to the same periods in 2021, primarily due to an increase in marketing and business development. For the three months ended June 30, 2022, the total other expense increase was offset by a decrease in information processing and communications. The increase in marketing and business development was driven by higher card acquisition and brand advertising, and growth investments in consumer banking. The decrease in information processing and communications was due to software write-offs in the prior year period.
Discover card sales volume was $53.9 billion and $100.2 billion, respectively, for the three and six months ended June 30, 2022, which was an increase of 18.5% and 20.4%, respectively, as compared to the same periods in 2021. This volume growth was primarily driven by higher consumer spending across all spending categories.
Payment Services
Our Payment Services segment reported pretax income of $20 million and a pretax loss of $81 million, respectively, for the three and six months ended June 30, 2022, as compared to pretax income of $692 million and $744 million, respectively, for the same periods in 2021. The decrease in segment pretax income was primarily driven by the change in fair value of equity investments as a result of investments in payment service entities that are carried at fair value because the shares are actively traded. The fair value adjustments resulted in the recognition of unrealized losses in the current periods and unrealized gains in the prior year periods. This decrease was offset by an increase in realized gains on equity investments due to sales in the current periods.
Critical Accounting Estimates
In preparing our consolidated financial statements in conformity with accounting principles generally accepted in the U.S. ("GAAP"), management must make judgments and use estimates and assumptions about the effects of matters that are uncertain. For estimates that involve a high degree of judgment and subjectivity, it is possible that different estimates could reasonably be derived for the same period. For estimates that are particularly sensitive to changes in economic or market
conditions, significant changes to the estimated amount from period to period are also possible. Management believes the current assumptions and other considerations used to estimate amounts reflected in our consolidated financial statements are appropriate. However, if actual experience differs from the assumptions and other considerations used in estimating amounts in our consolidated financial statements, the resulting changes could have a material effect on our consolidated results of operations and, in certain cases, could have a material effect on our consolidated financial condition. Management has identified the estimates related to our allowance for credit losses as a critical accounting estimate.
Allowance for Credit Losses
The allowance for credit losses was approximately $6.8 billion at June 30, 2022, which reflects a $110 million build over March 31, 2022. The allowance for credit losses represents management’s estimate of expected credit losses over the remaining expected life of our financial assets measured at amortized cost and certain off-balance sheet loan commitments. Changes in the allowance for credit losses, and in the related provision for credit losses, can materially affect net income.
In estimating the expected credit losses, we use a combination of statistical models and qualitative analysis. There is a significant amount of judgment applied in selecting inputs and analyzing the results produced to estimate the allowance for credit losses. For more information on these judgments and our accounting policies and methodologies used to determine the allowance for credit losses, see "Management's Discussion and Analysis of Financial Condition and Results of Operations — Loan Quality," Note 4: Loan Receivables and Note 2: Summary of Significant Accounting Policies to our consolidated financial statements in our annual report on Form 10-K for the year ended December 31, 2021.
One of the key assumptions requiring significant judgment in estimating the current expected credit losses ("CECL") on a quarterly basis is the determination of the macroeconomic forecasts used in the loss forecast models. For the reasonable and supportable loss forecast period, we consider forecasts of multiple economic scenarios that generally include a base scenario with one or more optimistic (upside) or pessimistic (downside) scenarios. These scenarios incorporate a variety of macroeconomic variables, including annualized gross domestic product growth and unemployment rate. The scenarios that are chosen each quarter and the amount of weighting given to each scenario depend on a variety of factors including recent economic events, leading economic indicators, views of internal and third-party economists and industry trends. Assumptions about the macroeconomic environment are inherently uncertain and, as a result, actual changes in the allowance for credit losses may be different from the simulated scenario presented below.
To demonstrate the sensitivity of the estimated credit losses to the macroeconomic scenarios, we compared the modeled credit losses determined using our base and one or more adverse macroeconomic scenarios. Our allowance for credit losses would increase by approximately $387 million at June 30, 2022 if we applied 100% weight to the most adverse scenario in our sensitivity analysis to reflect the economic deterioration from a resurgence of COVID-19 and resulting economic stress, as well as increasing inflationary pressures, including worsening supply-chain disruptions and the influence of geopolitical events.
The sensitivity disclosed above is hypothetical. It is difficult to estimate how potential changes in any one factor or input, such as the weighting of macroeconomic forecasts, might affect the overall allowance for credit losses because we consider a variety of factors and inputs in estimating the allowance for credit losses. The macroeconomic scenarios used are constructed with interrelated projections of multiple economic variables, and loss estimates are produced that consider the historical correlation of those economic variables with credit losses. The inputs in the macroeconomic scenarios may not change at the same rate and may not be consistent across all geographies or product types, and changes in factors and inputs may be directionally inconsistent, such that improvement in one factor or input may offset deterioration in others. As a result, the sensitivity analysis above does not necessarily reflect the nature and extent of future changes in the allowance for credit losses. It is intended to provide insights into the impact of different judgments about the economy on our modeled loss estimates for the loan portfolio and does not imply any expectation of future losses. Furthermore, the hypothetical increase in our allowance for credit losses for loans does not incorporate the impact of management judgment for qualitative factors applied in the current allowance for credit losses, which may have a positive or negative effect on our actual financial condition and results of operations.
The overall economic environment directly impacts the macroeconomic variables that are used in the loss forecast models. If management used different assumptions about the economic environment in estimating expected credit losses, the impact to the allowance for credit losses could have a material effect on our consolidated financial condition and results of operations. In addition, if we experience a rapidly changing economic environment, as experienced during the COVID-19 pandemic, the uncertainty around the credit loss forecasts may increase, both due to the uncertainty of the economic forecasts and the challenges our models may have in incorporating them.
Earnings Summary
The following table outlines changes in our condensed consolidated statements of income (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | For the Three Months Ended June 30, | | 2022 vs. 2021
Increase (Decrease) | | For the Six Months Ended June 30, | | 2022 vs. 2021
Increase (Decrease) |
| | 2022 | | 2021 | | $ | | % | | 2022 | | 2021 | | $ | | % |
| Interest income | $ | 2,915 | | | $ | 2,589 | | | $ | 326 | | | 13 | % | | $ | 5,651 | | | $ | 5,235 | | | $ | 416 | | | 8 | % |
| Interest expense | 305 | | | 290 | | | 15 | | | 5 | % | | 562 | | | 606 | | | (44) | | | (7) | % |
| Net interest income | 2,610 | | | 2,299 | | | 311 | | | 14 | % | | 5,089 | | | 4,629 | | | 460 | | | 10 | % |
| Provision for credit losses | 549 | | | 135 | | | 414 | | | 307 | % | | 703 | | | (230) | | | 933 | | | 406 | % |
| Net interest income after provision for credit losses | 2,061 | | | 2,164 | | | (103) | | | (5) | % | | 4,386 | | | 4,859 | | | (473) | | | (10) | % |
| Other income | 614 | | | 1,280 | | | (666) | | | (52) | % | | 1,037 | | | 1,745 | | | (708) | | | (41) | % |
| Other expense | 1,223 | | | 1,222 | | | 1 | | | NM | | 2,353 | | | 2,303 | | | 50 | | | 2 | % |
| Income before income tax expense | 1,452 | | | 2,222 | | | (770) | | | (35) | % | | 3,070 | | | 4,301 | | | (1,231) | | | (29) | % |
| Income tax expense | 341 | | | 524 | | | (183) | | | (35) | % | | 717 | | | 1,010 | | | (293) | | | (29) | % |
| Net income | $ | 1,111 | | | $ | 1,698 | | | $ | (587) | | | (35) | % | | $ | 2,353 | | | $ | 3,291 | | | $ | (938) | | | (29) | % |
| Net income allocated to common stockholders | $ | 1,105 | | | $ | 1,688 | | | $ | (583) | | | (35) | % | | $ | 2,309 | | | $ | 3,234 | | | $ | (925) | | | (29) | % |
| | | | | | | | | | | | | | | |
Net Interest Income
The table that follows this section has been provided to supplement the discussion below and provide further analysis of net interest income and net interest margin. Net interest income represents the difference between interest income earned on our interest-earning assets and the interest expense incurred to finance those assets. We analyze net interest income in total by calculating net interest margin (net interest income as a percentage of average total loan receivables) and net yield on interest-earning assets (net interest income as a percentage of average total interest-earning assets). We also separately consider the impact of the level of loan receivables and the related interest yield and the impact of the cost of funds related to each of our funding sources, along with the income generated by our liquidity portfolio, on net interest income.
Our interest-earning assets consist of: (i) cash and cash equivalents primarily related to amounts on deposit with the Federal Reserve Bank of Philadelphia, (ii) restricted cash, (iii) other short-term investments, (iv) investment securities and (v) loan receivables. Our interest-bearing liabilities consist primarily of deposits, both direct-to-consumer and brokered, and long-term borrowings, including amounts owed to securitization investors. The following factors influence net interest income:
•The level and composition of loan receivables, including the proportion of credit card loans to other loans, as well as the proportion of loan receivables bearing interest at promotional rates as compared to standard rates;
•The credit performance of our loans, particularly with regard to charge-offs of finance charges, which reduce interest income;
•The terms of long-term borrowings and certificates of deposit upon initial offering, including maturity and interest rate;
•The interest rates necessary to attract and maintain direct-to-consumer deposits;
•The level and composition of other interest-earning assets, including our liquidity portfolio, and interest-bearing liabilities;
•Changes in the interest rate environment, including the levels of interest rates and the relationships among interest rate indices, such as the prime rate, the federal funds rate, the interest rate on reserve balances and LIBOR; and
•The effectiveness of interest rate swaps in our interest rate risk management program.
Net interest income increased for the three and six months ended June 30, 2022, as compared to the same periods in 2021, primarily driven by a higher average level of receivables and higher yields on loans. The increase in net interest income for the six months ended June 30, 2022 was also favorably impacted by lower funding costs. Interest income increased during the three and six months ended June 30, 2022, as compared to the same periods in 2021, due to a higher average level of loan receivables and higher market rates. Interest expense decreased during the six months ended June 30, 2022, as compared to the same period in 2021, due to higher coupon maturities and a lower funding base offset partially by increasing market rates. Interest expense for the three months ended June 30, 2022 was relatively flat, as compared to the same period in 2021, driven by increasing market rates offset primarily by higher coupon maturities.
Average Balance Sheet Analysis
(dollars in millions) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| For the Three Months Ended June 30, |
| | 2022 | | 2021 |
| | Average Balance | | Yield/Rate | | Interest | | Average Balance | | Yield/Rate | | Interest |
| Assets | | | | | | | | | | | |
| Interest-earning assets | | | | | | | | | | | |
| Cash and cash equivalents | $ | 8,629 | | | 0.88 | % | | $ | 19 | | | $ | 17,562 | | | 0.11 | % | | $ | 6 | |
| Restricted cash | 40 | | | 0.41 | % | | NM | | 897 | | | 0.02 | % | | NM |
| | | | | | | | | | | |
| Investment securities | 5,780 | | | 2.29 | % | | 33 | | | 9,222 | | | 2.06 | % | | 47 | |
Loan receivables(1) | | | | | | | | | | | |
Credit card loans(2) | 75,917 | | | 12.81 | % | | 2,424 | | | 67,420 | | | 12.52 | % | | 2,105 | |
| Private student loans | 10,164 | | | 7.74 | % | | 196 | | | 9,993 | | | 7.41 | % | | 184 | |
| Personal loans | 6,981 | | | 11.84 | % | | 206 | | | 6,884 | | | 12.76 | % | | 219 | |
| Other loans | 2,674 | | | 5.47 | % | | 37 | | | 1,999 | | | 5.59 | % | | 28 | |
| Total loan receivables | 95,736 | | | 12.00 | % | | 2,863 | | | 86,296 | | | 11.79 | % | | 2,536 | |
| Total interest-earning assets | 110,185 | | | 10.61 | % | | 2,915 | | | 113,977 | | | 9.11 | % | | 2,589 | |
| Allowance for credit losses | (6,644) | | | | | | | (7,342) | | | | | |
| Other assets | 5,874 | | | | | | | 5,971 | | | | | |
| Total assets | $ | 109,415 | | | | | | | $ | 112,606 | | | | | |
| Liabilities and Stockholders' Equity | | | | | | | | | | | |
| Interest-bearing liabilities | | | | | | | | | | | |
| Interest-bearing deposits | | | | | | | | | | | |
| Time deposits | $ | 20,054 | | | 1.62 | % | | 81 | | | $ | 24,772 | | | 1.89 | % | | 116 | |
Money market deposits(3) | 8,326 | | | 0.89 | % | | 19 | | | 8,199 | | | 0.53 | % | | 11 | |
| Other interest-bearing savings deposits | 43,546 | | | 0.68 | % | | 74 | | | 41,073 | | | 0.42 | % | | 43 | |
| Total interest-bearing deposits | 71,926 | | | 0.97 | % | | 174 | | | 74,044 | | | 0.92 | % | | 170 | |
| Borrowings | | | | | | | | | | | |
| Short-term borrowings | 141 | | | 0.95 | % | | NM | | — | | | — | % | | — | |
Securitized borrowings(4)(5) | 8,262 | | | 1.87 | % | | 39 | | | 10,305 | | | 1.01 | % | | 26 | |
Other long-term borrowings(5)(6) | 9,184 | | | 4.02 | % | | 92 | | | 10,211 | | | 3.66 | % | | 94 | |
| Total borrowings | 17,587 | | | 2.99 | % | | 131 | | | 20,516 | | | 2.33 | % | | 120 | |
| Total interest-bearing liabilities | 89,513 | | | 1.36 | % | | 305 | | | 94,560 | | | 1.23 | % | | 290 | |
| Other liabilities and stockholders' equity | 19,902 | | | | | | | 18,046 | | | | | |
| Total liabilities and stockholders' equity | $ | 109,415 | | | | | | | $ | 112,606 | | | | | |
| Net interest income | | | | | $ | 2,610 | | | | | | | $ | 2,299 | |
Net interest margin(7) | | | 10.94 | % | | | | | | 10.68 | % | | |
Net yield on interest-earning assets(8) | | | 9.50 | % | | | | | | 8.09 | % | | |
Interest rate spread(9) | | | 9.25 | % | | | | | | 7.88 | % | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| For the Six Months Ended June 30, |
| | 2022 | | 2021 |
| | Average
Balance | | Yield/Rate | | Interest | | Average
Balance | | Yield/Rate | | Interest |
| Assets | | | | | | | | | | | |
| Interest-earning assets | | | | | | | | | | | |
| Cash and cash equivalents | $ | 8,574 | | | 0.54 | % | | $ | 23 | | | $ | 17,521 | | | 0.11 | % | | $ | 11 | |
| Restricted cash | 405 | | | 0.04 | % | | NM | | 519 | | | 0.03 | % | | NM |
| Other short-term investments | — | | | — | % | | — | | | 354 | | | 0.12 | % | | NM |
| Investment securities | 6,142 | | | 2.26 | % | | 69 | | | 9,478 | | | 2.07 | % | | 97 | |
Loan receivables(1) | | | | | | | | | | | |
Credit card loans(2)(3) | 74,487 | | | 12.70 | % | | 4,692 | | | 68,068 | | | 12.62 | % | | 4,259 | |
| Private student loans | 10,272 | | | 7.58 | % | | 386 | | | 10,101 | | | 7.39 | % | | 370 | |
| Personal loans | 6,945 | | | 11.96 | % | | 412 | | | 6,979 | | | 12.79 | % | | 442 | |
| Other loans | 2,517 | | | 5.53 | % | | 69 | | | 1,948 | | | 5.76 | % | | 56 | |
| Total loan receivables | 94,221 | | | 11.90 | % | | 5,559 | | | 87,096 | | | 11.87 | % | | 5,127 | |
| Total interest-earning assets | 109,342 | | | 10.42 | % | | 5,651 | | | 114,968 | | | 9.18 | % | | 5,235 | |
| Allowance for credit losses | (6,730) | | | | | | | (7,776) | | | | | |
| Other assets | 6,060 | | | | | | | 6,067 | | | | | |
Total assets(4) | $ | 108,672 | | | | | | | $ | 113,259 | | | | | |
| Liabilities and Stockholders’ Equity | | | | | | | | | | | |
| Interest-bearing liabilities | | | | | | | | | | | |
| Interest-bearing deposits | | | | | | | | | | | |
| Time deposits | $ | 19,989 | | | 1.57 | % | | 156 | | | $ | 25,899 | | | 1.97 | % | | 253 | |
| Money market deposits | 8,267 | | | 0.74 | % | | 30 | | | 8,173 | | | 0.53 | % | | 21 | |
| Other interest-bearing savings deposits | 43,020 | | | 0.59 | % | | 127 | | | 40,608 | | | 0.44 | % | | 89 | |
| Total interest-bearing deposits | 71,276 | | | 0.89 | % | | 313 | | | 74,680 | | | 0.98 | % | | 363 | |
| Borrowings | | | | | | | | | | | |
| Short-term borrowings | 402 | | | 0.58 | % | | 1 | | | — | | | — | % | | — | |
Securitized borrowings(5)(6)(7) | 8,002 | | | 1.58 | % | | 63 | | | 10,565 | | | 1.04 | % | | 54 | |
Other long-term borrowings(8)(9) | 9,307 | | | 4.01 | % | | 185 | | | 10,285 | | | 3.69 | % | | 189 | |
| Total borrowings | 17,711 | | | 2.83 | % | | 249 | | | 20,850 | | | 2.35 | % | | 243 | |
| Total interest-bearing liabilities | 88,987 | | | 1.27 | % | | 562 | | | 95,530 | | | 1.28 | % | | 606 | |
Other liabilities and stockholders’ equity(8) | 19,686 | | | | | | | 17,729 | | | | | |
| Total liabilities and stockholders’ equity | $ | 108,673 | | | | | | | $ | 113,259 | | | | | |
| Net interest income | | | | | $ | 5,089 | | | | | | | $ | 4,629 | |
Net interest margin(9) | | | 10.89 | % | | | | | | 10.72 | % | | |
Net yield on interest-earning assets(10) | | | 9.39 | % | | | | | | 8.12 | % | | |
Interest rate spread(11) | | | 9.15 | % | | | | | | 7.90 | % | | |
| | | | | | | | | | | |
(1)Average balances of loan receivables and yield calculations include non-accruing loans. If the non-accruing loan balances were excluded, there would not be a material impact on the amounts reported above.
(2)Interest income on credit card loans includes $86 million and $71 million of amortization of balance transfer fees for the three months ended June 30, 2022 and 2021, respectively, and $162 million and $144 million for the six months ended June 30, 2022 and 2021, respectively.
(3)Includes the impact of interest rate swap agreements used to change a portion of floating-rate assets to fixed-rate assets for the three and six months ended June 30, 2022 and 2021.
(4)The return on average assets, based on net income, was 1.02% and 1.51% for the three months ended June 30, 2022 and 2021, respectively, and 2.17% and 2.91% for the six months ended June 30, 2022 and 2021, respectively.
(5)Includes the impact of one terminated derivative formerly designated as a cash flow hedge for the three and six months ended June 30, 2022 and 2021.
(6)Includes the impact of interest rate swap agreements used to change a portion of fixed-rate funding to floating-rate funding for the three and six months ended June 30, 2022 and 2021.
(7)Includes the impact of terminated derivatives formerly designated as fair value hedges for the three and six months ended June 30, 2022 and 2021.
(8)The return on average stockholders' equity, based on net income, was 7.81% and 13.45% for the three months ended June 30, 2022 and 2021, respectively, and 16.79% and 27.32% for the six months ended June 30, 2022 and 2021, respectively.
(9)Net interest margin represents net interest income as a percentage of average total loan receivables.
(10)Net yield on interest-earning assets represents net interest income as a percentage of average total interest-earning assets.
(11)Interest rate spread represents the difference between the rate on total interest-earning assets and the rate on total interest-bearing liabilities.
Loan Quality
Impact of the COVID-19 Pandemic on the Loan Portfolio
The COVID-19 pandemic and its impact on the economy significantly affected our sales volume and credit card loan growth during the first half of 2021. We tightened credit standards for new accounts and for growing existing accounts across all products and reduced our marketing and customer acquisition expenditures at the onset of the pandemic. Recognizing the strong economic recovery from the COVID-19 pandemic-induced recession, we returned most of our underwriting criteria to pre-pandemic standards and resumed our investment in marketing and business development during the second quarter of 2021. This change in our credit underwriting, in addition to changes in consumer spending behavior, increased marketing and the re-opening of the U.S. economy upon expiration of certain COVID-19 containment measures, contributed to an increase in sales volume for the three and six months ended June 30, 2022, when compared to the same periods in 2021. Our outstanding loan receivables as of June 30, 2022, increased when compared to December 31, 2021, due to strong sales and new account growth.
Troubled debt restructuring ("TDR") program balances and the number of accounts reported as TDRs were favorably impacted by accounting and financial reporting exemptions provided by the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") for the year ended December 31, 2021. See Note 4: Loan Receivables to our annual report on Form 10-K for the year ended December 31, 2021, for more information about the impact of the CARES Act on loan modifications.
The table below reflects the number and balance of both new loan modifications reported as TDRs and new loan modifications excluded from the TDR designation pursuant to the CARES Act (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | |
| Accounts that entered a loan modification program and were classified as TDRs during the period | | Accounts that entered a loan modification program and were exempt from the TDR designation pursuant to the CARES Act(1) |
| Number of Accounts | | Balances | | Number of Accounts | | Balances |
For the Three Months Ended June 30, 2022 | | | | | | | |
| Credit card loans | 49,341 | | | $ | 313 | | | — | | | $ | — | |
| Private student loans | 1,523 | | | $ | 29 | | | — | | | $ | — | |
| Personal loans | 1,603 | | | $ | 22 | | | — | | | $ | — | |
| | | | | | | |
For the Three Months Ended June 30, 2021 | | | | | | | |
| Credit card loans | 14,221 | | | $ | 94 | | | 23,983 | | | $ | 177 | |
| Private student loans | 127 | | | $ | 3 | | | 2,666 | | | $ | 50 | |
| Personal loans | 824 | | | $ | 11 | | | 261 | | | $ | 4 | |
| | | | | | | |
For the Six Months Ended June 30, 2022 | | | | | | | |
| Credit card loans | 103,852 | | | $ | 657 | | | — | | | $ | — | |
| Private student loans | 3,278 | | | $ | 60 | | | — | | | $ | — | |
| Personal loans | 2,762 | | | $ | 37 | | | — | | | $ | — | |
| | | | | | | |
For the Six Months Ended June 30, 2021 | | | | | | | |
| Credit card loans | 34,923 | | | $ | 229 | | | 69,524 | | | $ | 497 | |
| Private student loans | 253 | | | $ | 5 | | | 4,713 | | | $ | 89 | |
| Personal loans | 2,214 | | | $ | 28 | | | 938 | | | $ | 15 | |
| | | | | | | |
(1)Accounts that entered into a loan modification on or after January 1, 2022, are not eligible for this exemption.
The number and balance of new credit card loan modifications increased during the three months ended June 30, 2022, when compared to total modifications, including both TDRs and those exempt from the TDR designation, in the same period in 2021. The increase was primarily due to the expiration of government stimulus and disaster relief programs.
During the six months ended June 30, 2022, the number of new credit card loan modifications was relatively flat, when compared to total modifications, including both TDRs and those exempt from the TDR designation, in the same period in 2021. The balance of new credit card loan modifications decreased due to a decline in the average balance of new credit card loan modifications.
The number and balance of new private student loan modifications decreased during the three and six months ended June 30, 2022, when compared to total modifications, including both TDRs and those exempt from the TDR designation, in the same periods in 2021. The decrease was primarily due to program eligibility changes.
The number and balance of new personal loan modifications increased during the three months ended June 30, 2022, when compared to total modifications, including both TDRs and those exempt from the TDR designation, in the same period in 2021. The increase was primarily driven by the expiration of government stimulus and disaster relief programs. During the six months ended June 30, 2022, the number and balance of new personal loans modifications decreased when compared to total modifications, including both TDRs and those exempt from the TDR designation, in the same periods of 2021. The decrease was primarily due to program eligibility changes.
The following table provides the number of accounts that exited a temporary loan modification program that were exempt from the TDR designation pursuant to the CARES Act and corresponding outstanding balances along with the amount of the outstanding balances that were delinquent (30 or more days past due) upon exiting the temporary loan modification program (dollars in millions):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| For the Three Months Ended June 30, | | |
| 2022 | | 2021 | | | | | | |
| Number of Accounts | | Outstanding Balances | | Balances Delinquent(1) | | Number of Accounts | | Outstanding Balances | | Balances Delinquent(1) | | | | | | |
| Credit card loans | 22,054 | | | $ | 131 | | | $ | 29 | | | 54,066 | | | $ | 320 | | | $ | 44 | | | | | | | |
Private student loans | 1,603 | | | $ | 32 | | | NM | | 1,876 | | | $ | 34 | | | NM | | | | | | |
Personal loans | 179 | | | $ | 2 | | | NM | | 1,406 | | | $ | 19 | | | NM | | | | | | |
| | | | | | | | | | | | | | | | | |
| For the Six Months Ended June 30, | | | | | | |
| 2022 | | 2021 | | | | | | |
| Number of Accounts | | Outstanding Balances | | Balances Delinquent(1) | | Number of Accounts | | Outstanding Balances | | Balances Delinquent(1) | | | | | | |
| Credit card loans | 59,392 | | | $ | 328 | | | $ | 66 | | | 113,645 | | | $ | 701 | | | $ | 94 | | | | | | | |
| Private student loans | 3,465 | | | $ | 67 | | | NM | | 3,734 | | | $ | 66 | | | NM | | | | | | |
| Personal loans | 528 | | | $ | 7 | | | NM | | 2,794 | | | $ | 40 | | | NM | | | | | | |
| | | | | | | | | | | | | | | | | |
(1)Includes balances charged off at the end of the month the account exited the temporary loan modification program. The balances charged off were not meaningful for the three and six months ended June 30, 2022 and 2021.
Our estimate of expected loss reflected in our allowance for credit losses includes the risk associated with all loans, including all modified loans. Refer to Note 3: Loan Receivables to our condensed consolidated financial statements for more details on modification programs, TDRs and the allowance for credit losses.
Loan receivables consist of the following (dollars in millions): | | | | | | | | | | | |
| June 30,
2022 | | December 31, 2021 |
| Credit card loans | $ | 79,237 | | | $ | 74,369 | |
| Other loans | | | |
| Private student loans | 10,074 | | | 10,113 | |
| Personal loans | 7,145 | | | 6,936 | |
| Other loans | 2,845 | | | 2,266 | |
| Total other loans | 20,064 | | | 19,315 | |
| Total loan receivables | 99,301 | | | 93,684 | |
| Allowance for credit losses | (6,757) | | | (6,822) | |
| Net loan receivables | $ | 92,544 | | | $ | 86,862 | |
| | | |
Provision and Allowance for Credit Losses
Provision for credit losses is the expense related to maintaining the allowance for credit losses at an appropriate level to absorb the estimate of credit losses anticipated over the remaining expected life of loan receivables at each period end date. In deriving the estimate of expected credit losses, we consider the collectability of principal, interest and fees associated with our loan receivables. We also consider expected recoveries of amounts that were either previously charged off or are expected to be charged-off. Establishing the estimate for expected credit losses requires significant management judgment. The factors that influence the provision for credit losses include:
•Increases or decreases in outstanding loan balances, including:
•Changes in consumer spending, payment and credit utilization behaviors;
•The level of originations and maturities; and
•Changes in the overall mix of accounts and products within the portfolio;
•The credit quality of the loan portfolio, which reflects our credit granting practices and the effectiveness of collection efforts, among other factors;
•The impact of general economic conditions on the consumer, including national and regional conditions, unemployment levels, bankruptcy trends and interest rate movements;
•The level and direction of historical losses; and
•Regulatory changes or new regulatory guidance.
Refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Estimates" and Note 3: Loan Receivables to our condensed consolidated financial statements for more details on how we estimate the allowance for credit losses.
The following tables provide changes in our allowance for credit losses (dollars in millions):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| For the Three Months Ended June 30, 2022 |
| | Credit Card Loans | | Private Student Loans | | Personal Loans | | Other Loans | | Total Loans |
| Balance at March 31, 2022 | $ | 5,120 | | | $ | 870 | | | $ | 613 | | | $ | 44 | | | $ | 6,647 | |
| Additions | | | | | | | | | |
Provision for credit losses(1) | 568 | | | (11) | | | (20) | | | 2 | | | 539 | |
| Deductions | | | | | | | | | |
| Charge-offs | (587) | | | (33) | | | (39) | | | — | | | (659) | |
| Recoveries | 206 | | | 6 | | | 18 | | | — | | | 230 | |
| Net charge-offs | (381) | | | (27) | | | (21) | | | — | | | (429) | |
| Other | — | | | — | | | — | | | — | | | — | |
| Balance at June 30, 2022 | $ | 5,307 | | | $ | 832 | | | $ | 572 | | | $ | 46 | | | $ | 6,757 | |
| | | | | | | | | |
| For the Three Months Ended June 30, 2021 |
| | Credit Card Loans | | Private Student Loans | | Personal Loans | | Other Loans | | Total Loans |
| Balance at March 31, 2021 | $ | 5,640 | | | $ | 862 | | | $ | 804 | | | $ | 41 | | | $ | 7,347 | |
| Additions | | | | | | | | | |
Provision for credit losses(1) | 181 | | | (21) | | | (28) | | | 3 | | | 135 | |
| Deductions | | | | | | | | | |
| Charge-offs | (620) | | | (20) | | | (48) | | | — | | | (688) | |
| Recoveries | 208 | | | 7 | | | 17 | | | — | | | 232 | |
| Net charge-offs | (412) | | | (13) | | | (31) | | | — | | | (456) | |
| Other | — | | | — | | | — | | | — | | | — | |
| Balance at June 30, 2021 | $ | 5,409 | | | $ | 828 | | | $ | 745 | | | $ | 44 | | | $ | 7,026 | |
| | | | | | | | | |
| For the Six Months Ended June 30, 2022 |
| | Credit Card Loans | | Private Student Loans | | Personal Loans | | Other Loans | | Total Loans |
Balance at December 31, 2021 | $ | 5,273 | | | $ | 843 | | | $ | 662 | | | $ | 44 | | | $ | 6,822 | |
| Additions | | | | | | | | | |
Provision for credit losses(1) | 746 | | | 34 | | | (50) | | | 2 | | | 732 | |
| Deductions | | | | | | | | | |
| Charge-offs | (1,128) | | | (57) | | | (77) | | | — | | | (1,262) | |
| Recoveries | 416 | | | 12 | | | 37 | | | — | | | 465 | |
| Net charge-offs | (712) | | | (45) | | | (40) | | | — | | | (797) | |
| Other | — | | | — | | | — | | | — | | | — | |
| Balance at June 30, 2022 | $ | 5,307 | | | $ | 832 | | | $ | 572 | | | $ | 46 | | | $ | 6,757 | |
| | | | | | | | | |
| For the Six Months Ended June 30, 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) | (196) | | | 15 | | | (32) | | | 6 | | | (207) | |
| Deductions | | | | | | | | | |
| Charge-offs | (1,283) | | | (40) | | | (112) | | | — | | | (1,435) | |
| Recoveries | 397 | | | 13 | | | 32 | | | — | | | 442 | |
| Net charge-offs | (886) | | | (27) | | | (80) | | | — | | | (993) | |
| Other | — | | | — | | | — | | | — | | | — | |
Balance at June 30, 2021 | $ | 5,409 | | | $ | 828 | | | $ | 745 | | | $ | 44 | | | $ | 7,026 | |
| | | | | | | | | |
(1)Excludes a $10 million adjustment of the liability for expected credit losses on unfunded commitments for the three months ended June 30, 2022, and $29 million and $23 million for the six months ended June 30, 2022 and 2021, respectively, as the liability is recorded in accrued expenses and other liabilities in our condensed consolidated statements of financial condition.
The allowance for credit losses was approximately $6.8 billion at June 30, 2022, which reflects a $110 million build over March 31, 2022 and a $65 million release from December 31, 2021. The build in the allowance for credit losses between June 30, 2022 and March 31, 2022, was driven by loan growth, partially offset by the continued strength of our loan portfolio's credit performance. The release in the allowance for credit losses between June 30, 2022 and December 31, 2021, was primarily driven by the continued strength of our loan portfolio's credit performance.
Our allowance estimation process begins with a loss forecast that uses certain macroeconomic variables and multiple macroeconomic scenarios among its inputs. In estimating the allowance at June 30, 2022, we used a macroeconomic forecast that projected (i) a peak unemployment rate of 5.0%, decreasing to 4.6% through the end of 2022 and 2023; and (ii) 2.5% and 1.5% annualized growth in the real gross domestic product for 2022 and 2023, respectively. Labor market conditions, which historically have been an important determinant of credit loss trends, remain strong as of June 30, 2022. The unemployment rate and both initial and continuing jobless claims remain near their historical lows. In addition, a very high number of job openings indicates robust labor demand.
In estimating expected credit losses, we considered the uncertainties associated with borrower behavior and payment trends, as well as higher consumer price inflation experienced in the first half of 2022 and the fiscal and monetary policy responses to that inflation. During the first half of 2022, the Federal Reserve raised its benchmark federal funds rate multiple times and signaled additional rate hikes throughout the remainder of the year. In recognition of the evolving macroeconomic environment, the estimation of the allowance for credit losses has required significant management judgment.
The forecast period we deemed to be reasonable and supportable was 18 months for all periods presented. The 18-month reasonable and supportable forecast period was deemed appropriate given the current economic conditions and relative consistency among the macroeconomic forecasts. For all periods presented, we determined that a reversion period of 12 months was appropriate for similar reasons. We applied a weighted reversion method to provide a more reasonable transition to historical losses for all loan products for all periods presented.
The provision for credit losses is the amount of expense realized after considering the level of net charge-offs in the period and the required amount of allowance for credit losses at the balance sheet date. For the three months ended June 30, 2022, the provision for credit losses increased by $404 million, or 299%, compared to the same period in 2021, primarily due to a reserve build in the current period versus a reserve release in the prior period. The reserve build during the three months ended June 30, 2022, was primarily driven by loan growth, partially offset by the continued strength of our portfolio's credit quality. The reserve release for the three months ended June 30, 2021, was primarily driven by improvements in the macroeconomic factors and continued stable credit performance. For the six months ended June 30, 2022, the provision for credit losses increased by $939 million, or 454%, compared to the same period in 2021, primarily due to a lower reserve release in the current period compared to the prior period. The reserve release during the six months ended June 30, 2022, was driven by the continued strength of our portfolio's credit quality, partially offset by loan growth. The reserve release during the six months ended June 30, 2021, was primarily driven by improvements in the macroeconomic factors, continued stable performance and a reduction in loan receivables.
Net Charge-offs
Our net charge-offs include the principal amount of losses charged off less principal recoveries and exclude charged-off and recovered interest and fees and fraud losses. Charged-off and recovered interest and fees are recorded in interest income and loan fee income, respectively, which is effectively a reclassification of the provision for credit losses, while fraud losses are recorded in other expense.
The following table presents amounts and rates of net charge-offs of key loan products (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | For the Three Months Ended June 30, | | For the Six Months Ended June 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
| | $ | | % | | $ | | % | | $ | | % | | $ | | % |
| Credit card loans | $ | 381 | | | 2.01 | % | | $ | 412 | | | 2.45 | % | | $ | 712 | | | 1.93 | % | | $ | 886 | | | 2.63 | % |
| Private student loans | $ | 27 | | | 1.08 | % | | $ | 13 | | | 0.53 | % | | $ | 45 | | | 0.88 | % | | $ | 27 | | | 0.53 | % |
| Personal loans | $ | 21 | | | 1.21 | % | | $ | 31 | | | 1.80 | % | | $ | 40 | | | 1.17 | % | | $ | 80 | | | 2.30 | % |
| | | | | | | | | | | | | | | |
The net charge-offs and net charge off rates for credit card and personal loans decreased for the three and six months ended June 30, 2022, when compared to the same periods in 2021. The decrease in net charge-offs for credit card was
primarily driven by lower average balances at charge off. The net charge-off rate for credit card also benefited from higher average outstanding loan receivables period-over-period. The decrease in net charge-offs for personal loans was mainly driven by the continued benefit from tighter credit underwriting standards implemented in 2020. The net charge-offs and net charge off rate for private student loans increased for the three and six months ended June 30, 2022, when compared to the same periods in 2021. The increase in net charge-offs was driven by the normalization of credit and the diminishing benefit from pandemic programs.
Delinquencies
Delinquencies are an indicator of credit quality at a point in time. A loan balance is considered delinquent when contractual payments on the loan become 30 days past due.
The following table presents the amounts and delinquency rates of key loan products that are 30 and 90 days or more delinquent, loan receivables that are not accruing interest regardless of delinquency and loans restructured in TDR programs (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | |
| | June 30, 2022 | | December 31, 2021 |
| | $ | | % | | $ | | % |
| Loans 30 or more days delinquent | | | | | | | |
| Credit card loans | $ | 1,392 | | | 1.76 | % | | $ | 1,232 | | | 1.66 | % |
| Private student loans | $ | 168 | | | 1.66 | % | | $ | 157 | | | 1.55 | % |
| Personal loans | $ | 45 | | | 0.63 | % | | $ | 48 | | | 0.69 | % |
| | | | | | | |
| Total loan receivables | $ | 1,621 | | | 1.61 | % | | $ | 1,451 | | | 1.55 | % |
| | | | | | | |
Loans 90 or more days delinquent(1) | | | | | | | |
| Credit card loans | $ | 633 | | | 0.80 | % | | $ | 562 | | | 0.76 | % |
| Private student loans | $ | 40 | | | 0.39 | % | | $ | 36 | | | 0.35 | % |
| Personal loans | $ | 13 | | | 0.18 | % | | $ | 13 | | | 0.20 | % |
| | | | | | | |
| Total loan receivables | $ | 694 | | | 0.69 | % | | $ | 618 | | | 0.66 | % |
| | | | | | | |
| Loans not accruing interest | $ | 199 | | | 0.18 | % | | $ | 225 | | | 0.24 | % |
| | | | | | | |
| Troubled debt restructurings: | | | | | | | |
Credit card loans(2)(3)(4) | | | | | | | |
| Currently enrolled | $ | 1,178 | | | 1.49 | % | | $ | 833 | | | 1.12 | % |
| No longer enrolled | 214 | | | 0.27 | | | 267 | | | 0.36 | |
| Total credit card loans | $ | 1,392 | | | 1.76 | % | | $ | 1,100 | | | 1.48 | % |
Private student loans(5) | $ | 284 | | | 2.82 | % | | $ | 249 | | | 2.46 | % |
Personal loans(6) | $ | 175 | | | 2.45 | % | | $ | 187 | | | 2.70 | % |
| | | | | | | |
(1)Credit card loans that were 90 or more days delinquent at June 30, 2022 and December 31, 2021, included $61 million and $73 million, respectively, in modified loans exempt from the TDR designation pursuant to the CARES Act. Within private student and personal loans that were 90 or more days delinquent at June 30, 2022 and December 31, 2021, the respective amounts associated with modifications exempt from the TDR designation under the CARES Act were immaterial.
(2)We estimate that interest income recognized on credit card loans restructured in TDR programs was $29 million and $27 million for the three months ended June 30, 2022 and 2021, respectively, and $52 million and $60 million for the six months ended June 30, 2022 and 2021, respectively. We do not separately track interest income on loans in TDR programs. We estimate this amount by applying an average interest rate to the average loans in the various TDR programs.
(3)We estimate that the incremental interest income that would have been recorded in accordance with the original terms of credit card loans restructured in TDR programs was $33 million and $35 million for the three months ended June 30, 2022 and 2021, respectively, and $63 million and $72 million for the six months ended June 30, 2022 and 2021, respectively. We do not separately track the amount of incremental interest income that would have been recorded if the loans in TDR programs had not been restructured and interest had instead been recorded in accordance with the original terms. We estimate this amount by applying the difference between the average interest rate earned on non-modified loans and the average interest rate earned on loans in the TDR programs to the average loans in the TDR programs.
(4)Credit card loans restructured in TDR programs include $66 million and $45 million at June 30, 2022 and December 31, 2021, respectively, which are also included in loans 90 or more days delinquent.
(5)Private student loans restructured in TDR programs include $8 million and $7 million at June 30, 2022 and December 31, 2021, respectively, which are also included in loans 90 or more days delinquent.
(6)Personal loans restructured in TDR programs include $4 million at June 30, 2022 and December 31, 2021, which are also included in loans 90 or more days delinquent.
The 30-day and 90-day delinquency rates in the table above include all loans, including TDRs, modified loans exempt from TDR status and prior modifications that are no longer required to be reported as TDRs. The 30-day and 90-day
delinquency rates for credit card and private student loans at June 30, 2022, increased compared to December 31, 2021. The increase was primarily driven by the normalization of credit as the impacts of government stimulus and disaster relief programs continue to wane. The 30-day and 90-day delinquency rates for personal loans at June 30, 2022, decreased compared to December 31, 2021, driven by continued benefit from tighter underwriting standards that we implemented in 2020.
The balance of credit card and private student loans reported as TDRs increased at June 30, 2022, compared to December 31, 2021, primarily due to the expiration of the CARES Act exemption for new modifications effective January 1, 2022. The balance of personal loans reported as TDRs decreased at June 30, 2022, compared to December 31, 2021, primarily due to the impact of tighter underwriting standards that were implemented in early 2020, resulting in a lower balance of personal loans entering into our loan modification programs, partially offset by enrollments in loan modification programs that are no longer exempt from the TDR designation under the CARES Act. To provide additional clarity with respect to credit card loans classified as TDRs, the table above presents loans that are currently enrolled in modification programs separately from loans that have exited those programs but retain that classification.
The following table provides the balance of loan receivables restructured through a temporary loan modification program that were exempt from the TDR designation pursuant to the CARES Act (dollars in millions):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | June 30, 2022 | | December 31, 2021 | | | | |
| | $ | | % | | $ | | % | | | | | | | | |
| Credit card loans | $ | 1,354 | | | 1.71 | % | | $ | 1,620 | | | 2.18 | % | | | | | | | | |
| Private student loans | $ | 211 | | | 2.09 | % | | $ | 242 | | | 2.39 | % | | | | | | | | |
| Personal loans | $ | 29 | | | 0.41 | % | | $ | 45 | | | 0.65 | % | | | | | | | | |
| | | | | | | | | | | | | | | |
We believe loan modification programs are useful in assisting customers experiencing financial difficulties and help to prevent defaults. We plan to continue to use loan modification programs as a means to provide relief to customers experiencing financial difficulties. See Note 3: Loan Receivables to our condensed consolidated financial statements for additional description of our use of loan modification programs to provide relief to customers experiencing financial hardship.
Modified and Restructured Loans
For information regarding modified and restructured loans, see "— Loan Quality — Delinquencies", "— Loan Quality — Impact of the COVID-19 Pandemic on the Loan Portfolio" and Note 3: Loan Receivables to our condensed consolidated financial statements.
Other Income
The following table presents the components of other income (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | For the Three Months Ended June 30, | | 2022 vs 2021
Increase (Decrease) | | For the Six Months Ended June 30, | | 2022 vs. 2021
Increase |
| 2022 | | 2021 | | $ | | % | | 2022 | | 2021 | | $ | | % |
Discount and interchange revenue, net(1) | $ | 390 | | | $ | 339 | | | $ | 51 | | | 15 | % | | $ | 710 | | | $ | 580 | | | $ | 130 | | | 22 | % |
| Protection products revenue | 42 | | | 43 | | | (1) | | | (2) | % | | 86 | | | 86 | | | — | | | — | % |
| Loan fee income | 142 | | | 105 | | | 37 | | | 35 | % | | 282 | | | 212 | | | 70 | | | 33 | % |
| Transaction processing revenue | 61 | | | 58 | | | 3 | | | 5 | % | | 118 | | | 109 | | | 9 | | | 8 | % |
| Unrealized (losses) gains on equity investments | (169) | | | 729 | | | (898) | | | (123) | % | | (357) | | | 729 | | | (1,086) | | | (149) | % |
| Realized gains on equity investments | 127 | | | — | | | 127 | | | NM | | 153 | | | — | | | 153 | | | NM |
| Other income | 21 | | | 6 | | | 15 | | | 250 | % | | 45 | | | 29 | | | 16 | | | 55 | % |
| Total other income | $ | 614 | | | $ | 1,280 | | | $ | (666) | | | (52) | % | | $ | 1,037 | | | $ | 1,745 | | | $ | (708) | | | (41) | % |
| | | | | | | | | | | | | | | |
(1)Net of rewards, including Cashback Bonus rewards, of $743 million and $598 million for the three months ended June 30, 2022 and 2021, respectively, and $1.4 billion and $1.1 billion for the six months ended June 30, 2022 and 2021, respectively..
Total other income decreased for the three and six months ended June 30, 2022, as compared to the same periods in 2021, primarily due to the change in fair value of equity investments offset by increases in realized gains on equity
investments, net discount and interchange revenue and loan fee income. The fair value adjustments are the result of investments in payment services entities that are carried at fair value because the shares are actively traded. The fair value adjustments resulted in the recognition of unrealized losses in the current periods and unrealized gains in the prior year periods. Realized gains on equity investments increased due to sales in the current periods. The increase in discount and interchange revenue was partially offset by an increase in rewards cost, both of which were the result of higher sales volume. Loan fee income increased primarily due to a higher volume of late payments.
Other Expense
The following table represents the components of other expense (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | For the Three Months Ended June 30, | | 2022 vs. 2021
Increase (Decrease) | | For the Six Months Ended June 30, | | 2022 vs. 2021
Increase (Decrease) |
| | 2022 | | 2021 | | $ | | % | | 2022 | | 2021 | | $ | | % |
| Employee compensation and benefits | $ | 515 | | | $ | 498 | | | $ | 17 | | | 3 | % | | $ | 1,015 | | | $ | 1,004 | | | $ | 11 | | | 1 | % |
| Marketing and business development | 254 | | | 175 | | | 79 | | | 45 | % | | 446 | | | 329 | | | 117 | | | 36 | % |
| Information processing and communications | 121 | | | 145 | | | (24) | | | (17) | % | | 246 | | | 254 | | | (8) | | | (3) | % |
| Professional fees | 189 | | | 187 | | | 2 | | | 1 | % | | 366 | | | 369 | | | (3) | | | (1) | % |
| Premises and equipment | 24 | | | 22 | | | 2 | | | 9 | % | | 48 | | | 46 | | | 2 | | | 4 | % |
| Other expense | 120 | | | 195 | | | (75) | | | (38) | % | | 232 | | | 301 | | | (69) | | | (23) | % |
| Total other expense | $ | 1,223 | | | $ | 1,222 | | | $ | 1 | | | NM | | $ | 2,353 | | | $ | 2,303 | | | $ | 50 | | | 2 | % |
| | | | | | | | | | | | | | | |
Total other expense was relatively flat for the three and six months ended June 30, 2022, as compared to the same periods in 2021, primarily due to an increase in marketing and business development offset by a decrease in other expense. For the three months ended June 30, 2022, the increase in marketing and business development was also offset by a decrease in information processing and communications. The increase in marketing and business development was driven by higher card acquisition and brand advertising, and growth investments in consumer banking. Other expense decreased due to a write-off of Diners Club intangible assets in the prior year periods. The decrease in information processing and communications was due to software write-offs in the prior year period.
Income Tax Expense
The following table presents the calculation of the effective income tax rate (dollars in millions): | | | | | | | | | | | | | | | | | | | | | | | |
| | For the Three Months Ended June 30, | | For the Six Months Ended June 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
| Income before income taxes | $ | 1,452 | | | $ | 2,222 | | | $ | 3,070 | | | $ | 4,301 | |
| Income tax expense | $ | 341 | | | $ | 524 | | | $ | 717 | | | $ | 1,010 | |
| Effective income tax rate | 23.5 | % | | 23.6 | % | | 23.4 | % | | 23.5 | % |
| | | | | | | |
Income tax expense decreased $183 million and $293 million for the three and six months ended June 30, 2022, respectively, as compared to the same periods in 2021, due to a decrease in pretax income. The effective tax rate was relatively flat for the three and six months ended June 30, 2022, as compared to the same periods in 2021.
Liquidity and Capital Resources
Funding and Liquidity
We seek to maintain stable, diversified and cost-effective funding sources and a strong liquidity profile to fund our business and repay or refinance our maturing obligations under normal operating conditions and periods of economic or financial stress. In managing our liquidity risk, we seek to maintain a prudent liability maturity profile and ready access to an ample store of primary and contingent liquidity sources. Our primary funding sources include direct-to-consumer and brokered deposits, public term asset-backed securitizations and other short-term and long-term borrowings. Our primary liquidity sources include a portfolio composed of highly liquid, unencumbered assets, including cash and cash equivalents and investment securities, as well as secured borrowing capacity through private term asset-backed securitizations and
Federal Home Loan Bank ("FHLB") advances. In addition, we have unused borrowing capacity at the Federal Reserve discount window, which provides another source of contingent liquidity.
Funding Sources
Deposits
We offer deposit products to customers through two channels: (i) direct marketing, internet origination and affinity relationships ("direct-to-consumer deposits"); and (ii) contractual arrangements with securities brokerage firms ("brokered deposits"). Direct-to-consumer deposits include online savings accounts, certificates of deposit, money market accounts, IRA savings accounts, IRA certificates of deposit and checking/debit accounts. Brokered deposits include certificates of deposit and sweep accounts. In December 2020, the Federal Deposit Insurance Corporation ("FDIC") issued the final rule on revisions to its brokered deposits regulation. In accordance with this final rule, our regulatory reporting reflects the changes required to deposit categorizations. Specifically, certain retail deposit products such as affinity deposits and deposits generated through certain sweep deposit relationships will no longer be categorized as brokered for regulatory reporting purposes. At June 30, 2022, we had $63.2 billion of direct-to-consumer deposits and $13.2 billion of brokered deposits, of which there are $67.8 billion of deposit balances due in less than one year and $8.6 billion of deposit balances due in one year or thereafter.
Credit Card Securitization Financing
We securitize credit card receivables as a source of funding. We access the asset-backed securitization market using the Discover Card Master Trust I ("DCMT") and the Discover Card Execution Note Trust ("DCENT"). In connection with our securitization transactions, credit card receivables are transferred to DCMT. DCMT has issued a certificate representing the beneficial interest in its credit card receivables to DCENT. We issue DCENT DiscoverSeries notes in public and private transactions, which are collateralized by the beneficial interest certificate held by DCENT. From time to time, we may add credit card receivables to DCMT to create sufficient funding capacity for future securitizations while managing seller's interest. We retain significant exposure to the performance of the securitized credit card receivables through holding the seller's interest and subordinated classes of DCENT DiscoverSeries notes. At June 30, 2022, we had $9.0 billion of outstanding public asset-backed securities and $3.2 billion of outstanding subordinated asset-backed securities that had been issued to our wholly owned subsidiaries.
The securitization structures include certain features designed to protect investors. The primary feature relates to the availability and adequacy of cash flows in the securitized pool of receivables to meet contractual requirements, the insufficiency of which triggers early repayment of the securities. We refer to this as "economic early amortization," which is based on excess spread levels. Excess spread is the amount by which income received with respect to the securitized credit card receivables during a collection period including interest collections, fees and interchange, exceeds the fees and expenses of DCENT during such collection period, including interest expense, servicing fees and charged-off receivables. In the event of an economic early amortization, which would occur if the excess spread fell below 0% on a three-month rolling average basis, we would be required to repay all outstanding securitized borrowings using available collections received with respect to the securitized credit card receivables. For the three months ended June 30, 2022, the DiscoverSeries three-month rolling average excess spread was 13.66%. The period of ultimate repayment would be determined by the amount and timing of collections received.
Through our wholly owned indirect subsidiary, Discover Funding LLC, we are required to maintain an interest in a contractual minimum level of receivables in DCMT in excess of the face value of outstanding investors' interests. This minimum interest is referred to as the minimum seller's interest. The required minimum seller's interest in the pool of trust receivables is approximately 7% in excess of the total investors' interests, which includes interests held by third parties as well as those interests held by us. If the level of receivables in DCMT were to fall below the required minimum, we would be required to add receivables from the unrestricted pool of receivables, which would increase the amount of credit card receivables restricted for securitization investors. A decline in the amount of the excess seller's interest could occur if balance repayments and charge-offs exceeded new lending on the securitized accounts or as a result of changes in total outstanding investors' interests. Seller's interest exhibits seasonality as higher receivable balance repayments tend to occur in the first calendar year quarter. If we could not add enough receivables to satisfy the minimum seller's interest requirement, an early amortization (or repayment) of investors' interests would be triggered.
An early amortization event would impair our liquidity and may require us to utilize our available non-securitization-related contingent liquidity or rely on alternative funding sources, which may or may not be available at the time. We have
several strategies we can deploy to prevent an early amortization event. For instance, we could add receivables to DCMT, which would reduce our available borrowing capacity at the Federal Reserve discount window. As of June 30, 2022, there were $24.8 billion of credit card receivables in the trust and no accounts were added to those restricted for securitization investors for the three and six months ended June 30, 2022. Alternatively, we could employ structured discounting, which was used effectively in 2009 to bolster excess spread and mitigate early amortization risk.
The following table summarizes expected contractual maturities of the investors' interests in credit card securitizations, excluding those that have been issued to our wholly owned subsidiaries (dollars in millions): | | | | | | | | | | | | | | | | | | |
| At June 30, 2022 | Total | | Less Than
One Year | | | One Year and Thereafter |
| Scheduled maturities of borrowings - owed to credit card securitization investors | $ | 9,006 | | | $ | 2,990 | | | | $ | 6,016 | |
| | | | | | |
The "AAA(sf)" and "Aaa(sf)" ratings of the DCENT DiscoverSeries Class A Notes issued to date have been based, in part, on an FDIC rule, which created a safe harbor that provides that the FDIC, as conservator or receiver, will not use its power to disaffirm or repudiate contracts, seek to reclaim or recover assets transferred in connection with a securitization, or recharacterize assets transferred in connection with a securitization as assets of the insured depository institution, provided such transfer satisfies the conditions for sale accounting treatment under previous GAAP. Although the implementation of Financial Accounting Standards Board ("FASB") Accounting Standards Codification Topic 860, Transfers and Servicing, no longer qualified certain transfers of assets for sale accounting treatment, the FDIC approved a final rule that preserved the safe-harbor treatment applicable to revolving trusts and master trusts, including DCMT, so long as those trusts would have satisfied the original FDIC safe harbor if evaluated under GAAP pertaining to transfers of financial assets in effect prior to December 2009. However, other legislative and regulatory developments may impact our ability or desire to issue asset-backed securities in the future.
Federal Home Loan Bank Advances
Discover Bank is a member bank of the FHLB of Chicago, one of 11 FHLBs that, along with the Office of Finance, compose the FHLB System. The FHLBs are government-sponsored enterprises of the U.S. ("U.S. GSEs") chartered to improve the availability of funds to support home ownership. As such, senior debt obligations of the FHLBs feature the same credit ratings as U.S. Treasury securities and are considered high-quality liquid assets for bank regulatory purposes. Consequently, the FHLBs benefit from consistent capital market access during nearly all macroeconomic and financial market conditions and low funding costs, which they pass on to their member banks when they borrow advances. Thus, we consider FHLB advances a stable and reliable funding source for Discover Bank for short-term contingent liquidity and long-term asset-liability management.
As a member of the FHLB of Chicago, Discover Bank has access to short- and long-term advance structures with maturities ranging from overnight to 30 years. At June 30, 2022, we had total committed borrowing capacity of $1.8 billion based on the amount and type of assets pledged, nearly all of which was outstanding as a short-term draw. Under certain stressed conditions, we could pledge our liquidity portfolio securities and borrow against them at a modest reduction to their value.
Other Long-Term Borrowings—Private Student Loans
At June 30, 2022, $93 million of principal was outstanding on securitized debt assumed as part of our acquisition of The Student Loan Corporation. Principal and interest payments on the underlying private student loans will reduce the balance of these secured borrowings over time.
Other Long-Term Borrowings—Corporate and Bank Debt
The following table provides a summary of Discover Financial Services (Parent Company) and Discover Bank outstanding fixed-rate debt (dollars in millions): | | | | | |
| At June 30, 2022 | Principal Amount Outstanding |
| Discover Financial Services (Parent Company) fixed-rate senior notes, maturing 2022-2027 | $ | 3,100 | |
| Discover Financial Services (Parent Company) fixed-rate retail notes, maturing 2022-2031 | $ | 167 | |
| Discover Bank fixed-rate senior bank notes, maturing 2023-2030 | $ | 5,350 | |
| Discover Bank fixed-rate subordinated bank notes, maturing 2028 | $ | 500 | |
| |
At June 30, 2022, $453 million of interest on our fixed-rate debt is due in less than one year and $1.2 billion of interest is due in one year and thereafter. See Note 6: Long-Term Borrowings to our condensed consolidated financial statements for more information on the maturities of our long-term borrowings. Certain DFS senior notes require us to offer to repurchase the notes at a price equal to 101% of their aggregate principal amount plus accrued and unpaid interest in the event of a change of control involving us and corresponding ratings downgrade below investment grade.
Short-Term Borrowings
As part of our regular funding strategy, we may, from time to time, borrow short-term funds in the federal funds market or the repurchase ("repo") market through repurchase agreements. Federal funds are short-term, unsecured loans between banks or other financial entities with a Federal Reserve account. Funds borrowed in the repo market are short-term, collateralized loans, usually secured with highly rated investment securities such as U.S. Treasury bills or notes, or mortgage bonds or debentures issued by government agencies or U.S. GSEs. At June 30, 2022, there were no outstanding balances in the federal funds market or under repurchase agreements. Additionally, we have access to short-term advance structures through the FHLB of Chicago and privately placed asset-backed securitizations. At June 30, 2022, there was $1.8 billion in short-term advances outstanding from the FHLB.
Additional Funding Sources
Private Asset-Backed Securitizations
We have access to committed borrowing capacity through privately placed asset-backed securitizations. While we may utilize funding from these private securitizations from time to time for normal business operations, their committed nature also makes them a reliable contingency funding source. Therefore, we reserve some undrawn capacity, informed by our liquidity stress test results, for potential contingency funding needs. At June 30, 2022, we had a total committed capacity of $3.5 billion, none of which was drawn. We seek to ensure the stability and reliability of these securitizations by staggering their maturity dates, renewing them approximately one year prior to their scheduled maturity dates and periodically drawing them for operational tests and seasonal funding needs.
Federal Reserve
Discover Bank has access to the Federal Reserve Bank of Philadelphia's discount window. As of June 30, 2022, Discover Bank had $36.5 billion of available borrowing capacity through the discount window based on the amount and type of assets pledged, primarily consumer loans. As of June 30, 2022, we have no borrowings outstanding under the discount window and reserve this capacity as a source of contingent liquidity.
Funding Uses
Our primary uses of funds include the extensions of loans and credit to customers, primarily through Discover Bank; the maintenance of sufficient working capital for routine operations; the service of our debt and capital obligations, including interest, principal and dividend payments; and the purchase of investment securities for our liquidity portfolio.
In addition to originating consumer loans to new customers, we also extend credit to existing customers, which primarily arises from agreements for unused lines of credit on certain credit cards and certain other loan products, provided there is no violation of conditions established in the related agreement. At June 30, 2022, our unused credit arrangements were approximately $223.3 billion. These arrangements, substantially all of which we can terminate at any time and which do
not necessarily represent future cash requirements, are periodically reviewed based on account usage, customer creditworthiness and loan qualification.
In the normal course of business, we enter into various contracts for goods and services, such as consulting, outsourcing, data, sponsorships, software licenses, telecommunications, global merchant acceptance and cashback rewards, among other things. These contracts are legally binding and specify all significant terms, including any applicable fixed future cash payments.
As of June 30, 2022, we have debt obligations, common stock and preferred stock outstanding. Refer to “— Funding Sources” and “— Capital” for more information related to our debt obligations and capital service, respectively, and the timing of expected payments.
We assess funding uses and liquidity needs under stressed and normal operating conditions, considering primary uses of funding, such as on-balance sheet loans and contingent uses of funding, such as the need to post additional collateral for derivatives positions. To anticipate funding needs under stress, we conduct liquidity stress tests to assess the impact of idiosyncratic, systemic and hybrid (i.e., idiosyncratic and systemic) scenarios with varying levels of liquidity risk reflecting a range of stress severity. If we determine we have excess cash and cash equivalents, we may invest in highly liquid, unencumbered assets that we expect to be able to convert to cash quickly and with little loss of value using the repo market or outright sales.
Guarantees
Guarantees are contracts or indemnification agreements that may require us to make payments to a guaranteed party based on changes in an underlying asset, liability, or equity security of a guaranteed party, rate or index. Also included in guarantees are contracts that may require the guarantor to make payments to a guaranteed party based on another entity’s failure to perform under an agreement. Our guarantees relate to transactions processed on the Discover Network and certain transactions processed by PULSE and Diners Club. In the ordinary course of business, we guarantee payment on behalf of subsidiaries relating to contractual obligations with external parties. The activities of the subsidiaries covered by any such guarantees are included in our consolidated financial statements. See Note 12: Commitments, Contingencies and Guarantees to our consolidated financial statements for further discussion regarding our guarantees.
Credit Ratings
Our borrowing costs and capacity in certain funding markets, including those for securitizations and unsecured senior and subordinated debt, may be affected by the credit ratings of DFS, Discover Bank and the securitization trusts. Downgrades in these credit ratings could result in higher interest expense on our unsecured debt and asset securitizations, as well as higher credit enhancement requirements for both our public and private asset securitizations. In addition to increased funding costs, deterioration in our credit ratings could reduce our borrowing capacity in the unsecured debt and asset securitization capital markets.
The table below reflects our current credit ratings and outlooks: | | | | | | | | | | | | | | | | | |
| Moody's Investors Service | | Standard & Poor's | | Fitch
Ratings |
| Discover Financial Services | | | | | |
| Senior unsecured debt | Baa3 | | BBB- | | BBB+ |
| Outlook for Discover Financial Services senior unsecured debt | Positive | | Stable | | Stable |
| Discover Bank | | | | | |
| Senior unsecured debt | Baa2 | | BBB | | BBB+ |
| Outlook for Discover Bank senior unsecured debt | Positive | | Stable | | Stable |
| Subordinated debt | Baa2 | | BBB- | | BBB |
| Discover Card Execution Note Trust (DCENT) | | | | | |
Class A(1) | Aaa(sf) | | AAA(sf) | | AAA(sf) |
| | | | | |
(1)An "sf" in the rating denotes rating agency identification for structured finance product ratings.
A credit rating is not a recommendation to buy, sell or hold securities and may be subject to revision or withdrawal at any time by the assigning rating organization. Each rating should be evaluated independently of any other rating. A credit
rating outlook reflects an agency's opinion regarding the likely rating direction over the medium term, often a period of about a year, and indicates the agency's belief that the issuer's credit profile is consistent with its current rating level at that point in time.
Liquidity
We seek to ensure that we have adequate liquidity to sustain business operations, fund asset growth and satisfy debt obligations under stressed and normal operating conditions. In addition to the funding sources discussed in the previous section, we also maintain highly liquid, unencumbered assets in our liquidity portfolio that we expect to be able to convert to cash quickly and with little loss of value using either the repo market or outright sales.
We maintain a liquidity risk and funding management policy, which outlines the overall framework and general principles we follow in managing liquidity risk across our business. The Board of Directors approves the policy and the Asset and Liability Management Committee (the "ALCO") is responsible for its implementation. Additionally, we maintain a liquidity management framework document that outlines the general strategies, objectives and principles we utilize to manage our liquidity position and the various liquidity risks inherent in our business model. We seek to balance the trade-offs between maintaining too much liquidity, which may be costly, with having too little liquidity, which could cause financial distress. The ALCO, chaired by our Treasurer, has cross-functional membership, and manages liquidity risk centrally. The ALCO monitors the liquidity risk profiles of DFS and Discover Bank and oversees any actions Corporate Treasury may take to ensure that we maintain ready access to our funding sources and sufficient liquidity to meet current and projected needs. In addition, the ALCO and our Board of Directors regularly review our compliance with our liquidity limits at DFS and Discover Bank, which are established in accordance with the liquidity risk appetite set by our Board of Directors.
We employ a variety of metrics to monitor and manage liquidity. We utilize early warning indicators ("EWIs") to detect emerging liquidity stress events and a reporting and escalation process designed to be consistent with regulatory guidance. The EWIs include both idiosyncratic and systemic measures and are monitored daily and reported to the ALCO regularly. A warning from one or more of these indicators triggers prompt review and decision-making by our senior management team and, in certain instances, may lead to the convening of a senior-level response team and activation of our contingency funding plan.
In addition, we conduct liquidity stress tests regularly and ensure contingency funding is in place to address potential liquidity shortfalls. We evaluate a range of stress scenarios that are designed according to regulatory requirements, including idiosyncratic, systemic and a combination of such events that could impact funding sources and our ability to meet liquidity needs. These scenarios measure the projected liquidity position at DFS and Discover Bank across a range of time horizons by comparing estimated contingency funding needs to available contingent liquidity.
Our primary contingency liquidity sources include our liquidity portfolio securities, which we could sell, repo or borrow against, and private securitizations with unused borrowing capacity. In addition, we could borrow FHLB advances by pledging securities to the FHLB of Chicago. Moreover, we have unused borrowing capacity with the Federal Reserve discount window, which provides an additional source of contingency liquidity. We seek to maintain sufficient liquidity to satisfy all maturing obligations and fund business operations for at least 12 months in a severe stress environment. In such an environment, we may also take actions to curtail the size of our balance sheet, which would reduce the need for funding and liquidity.
At June 30, 2022, our liquidity portfolio is composed of highly liquid, unencumbered assets, including cash and cash equivalents and investment securities. Cash and cash equivalents were primarily deposits with the Federal Reserve. Investment securities primarily included debt obligations of the U.S. Treasury and U.S. GSEs and residential mortgage-backed securities ("RMBS") issued by U.S. government agencies or U.S. GSEs. These investments are considered highly liquid and we expect to have the ability to raise cash by selling them, utilizing repurchase agreements or pledging certain of these investments to access secured funding. The size and composition of our liquidity portfolio may fluctuate based on the size of our balance sheet as well as operational requirements, market conditions and interest rate risk management objectives.
At June 30, 2022, our liquidity portfolio and undrawn credit facilities were $56.2 billion, which is $3.3 billion higher than the balance at December 31, 2021. Our liquidity portfolio and undrawn credit facilities grew in the second quarter of 2022 primarily as a result of the issuance of $1.4 billion of asset backed securitizations. During the three and six months ended June 30, 2022, the average balance of our liquidity portfolio was $14.5 billion and $14.9 billion, respectively. Our liquidity portfolio and undrawn facilities consist of the following (dollars in millions):
| | | | | | | | | | | |
| June 30,
2022 | | December 31,
2021 |
| Liquidity portfolio | | | |
Cash and cash equivalents(1) | $ | 10,694 | | | $ | 8,080 | |
| | | |
Investment securities(2) | 5,510 | | | 6,879 | |
| Total liquidity portfolio | 16,204 | | | 14,959 | |
Private asset-backed securitizations(3) | 3,500 | | | 3,500 | |
| Federal Home Loan Bank of Chicago | 12 | | | 150 | |
| Primary liquidity sources | 19,716 | | | 18,609 | |
Federal Reserve discount window(3) | 36,463 | | | 34,254 | |
| Total liquidity portfolio and undrawn credit facilities | $ | 56,179 | | | $ | 52,863 | |
| | | |
(1)Cash in the process of settlement and restricted cash are excluded from cash and cash equivalents for liquidity purposes.
(2)Excludes $12 million and $27 million of U.S. Treasury securities that have been pledged as swap collateral in lieu of cash as of June 30, 2022 and December 31, 2021, respectively.
(3)See "— Additional Funding Sources" for additional information.
Bank Holding Company Liquidity
The primary uses of funds at the unconsolidated DFS level include debt service obligations (interest payments and return of principal) and capital service and management activities, including dividend payments on capital instruments and the periodic repurchase of shares of our common stock. Our primary sources of funds at the bank holding company level include the proceeds from the issuance of unsecured debt and capital securities, as well as dividends from our subsidiaries, notably Discover Bank. Under periods of idiosyncratic or systemic stress, the bank holding company could lose or experience impaired access to the capital markets. In addition, our regulators have the discretion to restrict dividend payments from Discover Bank to the bank holding company.
We utilize a measure referred to as Number of Months of Pre-Funding to determine the length of time DFS can meet upcoming funding obligations, including common and preferred stock dividend payments and debt service obligations using existing cash resources. In managing this metric, we structure our debt maturity schedule to manage prudently the amount of debt maturing within a short period. See Note 6: Long-Term Borrowings to our condensed consolidated financial statements for further information regarding our debt.
Capital
Our primary sources of capital are the earnings generated by our businesses and the proceeds from issuances of capital securities. We seek to manage capital to a level and composition sufficient to support our businesses' growth, account for their risks, and meet regulatory requirements, rating agency targets and debt investor expectations. Within these constraints, we are focused on deploying capital in a manner that provides attractive returns to our stockholders. The level, composition and utilization of capital are influenced by changes in the economic environment, strategic initiatives and legislative and regulatory developments.
Under regulatory capital requirements adopted by the Federal Reserve and the FDIC, DFS, along with Discover Bank, must maintain minimum capital levels. Failure to meet minimum capital requirements can result in the initiation of certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could limit our business activities and have a direct material effect on our financial condition and operating results. We must meet specific capital requirements that involve quantitative measures of assets, liabilities and certain off-balance sheet items, as calculated under regulatory guidance and regulations. Current or future legislative or regulatory reforms, such as those related to the adoption of the CECL accounting model, may require us to hold more capital or adversely impact our capital level. We consider the potential impacts of these reforms in managing our capital position.
DFS and Discover Bank are subject to regulatory capital rules issued by the Federal Reserve and the 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 as they are U.S. banking organizations with consolidated total assets over $50 billion but not exceeding $250 billion and consolidated total on-balance sheet foreign exposures less than $10 billion. The Basel III rules require DFS and Discover Bank to maintain minimum risk-based capital and leverage ratios and define what constitutes capital for purposes of calculating those ratios.
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, we have elected to defer recognition of the estimated impact of CECL on regulatory capital for two years in accordance with the final rule; after that period of deferral, the estimated impact of CECL on regulatory capital will be phased in over three years, beginning in 2022. Electing this option raised our Common Equity Tier 1 ("CET1") capital ratios in 2022 and 2021. The phase-in of the CECL accounting model decreased CET1 by $537 million as of January 1, 2022. For additional information regarding the risk-based capital and leverage ratios, see Note 11: Capital Adequacy to our condensed consolidated financial statements.
On March 4, 2020, the Federal Reserve announced the SCB final rule, which imposes limitations on DFS' capital distributions if we do not maintain our risk-based capital ratios above stated regulatory minimum ratios based on the results of supervisory stress tests. Under this rule, DFS is required to assess whether our planned capital actions are consistent with the effective capital distribution limitations that will apply on a pro-forma basis throughout the planning horizon.
The SCB requirement is institution-specific and is calculated as the greater of (i) 2.5% and (ii) the sum of (a) the difference between DFS' actual CET1 ratio at the beginning of the forecast and the projected minimum CET1 ratio based on the Federal Reserve's models in its nine-quarter Severely Adverse stress scenario, plus (b) the sum of the dollar amount of DFS' planned common stock dividend distributions for each of the fourth through seventh quarters of its nine-quarter capital planning horizon, expressed as a percentage of RWAs. For Category IV firms, including DFS, the Federal Reserve calculates each firm's SCB biennially in even-numbered calendar years, and did so in 2022. In odd-numbered years, each firm subject to Category IV standards that did not opt-in to such year's supervisory stress tests as part of the Federal Reserve's CCAR process receives an adjusted SCB requirement that is updated to reflect its planned common stock dividends per the firm's annual capital plan. On August 5, 2021, the Federal Reserve notified DFS of its adjusted SCB requirement of 3.6% based on the planned common stock dividends in the 2021 Capital Plan. DFS’ SCB was effective on October 1, 2021, and slightly increased from our SCB in effect for the preceding year, which was 3.5%. See "— Regulatory Environment and Developments — Banking — Capital Standards and Stress Testing" for additional information.
DFS elected to not participate in the Federal Reserve's supervisory stress test in 2021, but did participate in 2022. As part of CCAR, DFS submitted an annual capital plan by the April 5, 2022 due date ("2022 Capital Plan"). On June 23, 2022, the Federal Reserve released results of the 2022 CCAR stress test. Discover’s results showed strong capital levels under stress, well above regulatory minimums. These results will be used to set the new SCB effective October 1, 2022. While the Federal Reserve will not announce final SCB requirements until August, Discover’s preliminary SCB is 2.5%, the lowest possible requirement.
At June 30, 2022, DFS and Discover Bank met the requirements for "well-capitalized" status under the Federal Reserve's Regulation Y and the prompt corrective action rules and corresponding FDIC requirements, respectively, exceeding the regulatory minimums to which they were subject under the applicable rules.
Basel III rules also require disclosures relating to market discipline. This series of disclosures is commonly referred to as "Pillar 3." The objective is to increase the transparency of capital requirements for banking organizations. We are required to make prescribed regulatory disclosures quarterly regarding our capital structure, capital adequacy, risk exposures and risk-weighted assets. We make the Pillar 3 disclosures publicly available on our website in a report called "Basel III Regulatory Capital Disclosures."
We disclose tangible common equity, which represents common equity less goodwill and intangibles. Management believes that common stockholders' equity excluding goodwill and intangibles is meaningful to investors as a measure of our true net asset value. At June 30, 2022, tangible common equity is considered to be a non-GAAP financial measure as it is not formally defined by GAAP or codified in the federal banking regulations. Other financial services companies may also disclose this measure and definitions may vary. We advise users of this information to exercise caution in comparing this measure for different companies.
The following table reconciles total common stockholders' equity (a GAAP financial measure) to tangible common equity (dollars in millions): | | | | | | | | | | | |
| June 30,
2022 | | December 31,
2021 |
Total common stockholders' equity(1) | $ | 12,708 | | | $ | 12,352 | |
| Less: goodwill | (255) | | | (255) | |
| | | |
| Tangible common equity | $ | 12,453 | | | $ | 12,097 | |
| | | |
(1)Total common stockholders' equity is calculated as total stockholders' equity less preferred stock.
Our Board of Directors declared the following common stock dividends during 2022 and 2021: | | | | | | | | | | | | | | | | | | | | |
| Declaration Date | | Record Date | | Payment Date | | Dividend per Share |
| 2022 | | | | | | |
| July 20, 2022 | | August 25, 2022 | | September 08, 2022 | | $ | 0.60 | |
| April 27, 2022 | | May 26, 2022 | | June 09, 2022 | | 0.60 | |
| January 18, 2022 | | February 18, 2021 | | March 04, 2021 | | 0.50 | |
| Total common stock dividends | | $ | 1.70 | |
| | | | | | |
| 2021 | | | | | | |
| October 19, 2021 | | November 24, 2021 | | December 09, 2021 | | $ | 0.50 | |
| July 20, 2021 | | August 19, 2021 | | September 02, 2021 | | 0.50 | |
| April 20, 2021 | | May 20, 2021 | | June 03, 2021 | | 0.44 | |
| January 19, 2021 | | February 18, 2021 | | March 04, 2021 | | 0.44 | |
| Total common stock dividends | | $ | 1.88 | |
| | | | | | |
Our Board of Directors declared the following Series C preferred stock dividends during 2022 and 2021: | | | | | | | | | | | | | | | | | | | | |
| Declaration Date | | Record Date | | Payment Date | | Dividend per Depositary Share |
| 2022 | | | | | | |
| July 20, 2022 | | October 14, 2022 | | October 31, 2022 | | $ | 27.50 | |
| January 18, 2022 | | April 15, 2022 | | May 02, 2022 | | 27.50 | |
| Total Series C preferred stock dividends | | $ | 55.00 | |
| | | | | | |
| 2021 | | | | | | |
| July 20, 2021 | | October 15, 2021 | | November 01, 2021 | | $ | 27.50 | |
| January 19, 2021 | | April 15, 2021 | | April 30, 2021 | | 27.50 | |
| Total Series C preferred stock dividends | | $ | 55.00 | |
| | | | | | |
Our Board of Directors declared the following Series D preferred stock dividends during 2022 and 2021: | | | | | | | | | | | | | | | | | | | | |
| Declaration Date | | Record Date | | Payment Date | | Dividend per Depositary Share |
| 2022 | | | | | | |
| July 20, 2022 | | September 08, 2022 | | September 23, 2022 | | $ | 30.625 | |
| January 18, 2022 | | March 08, 2022 | | March 23, 2022 | | 30.625 | |
| Total Series D preferred stock dividends | | $ | 61.25 | |
| | | | | | |
| 2021 | | | | | | |
| July 20, 2021 | | September 08, 2021 | | September 23, 2021 | | $ | 30.625 | |
January 19, 2021(1) | | March 08, 2021 | | March 23, 2021 | | 46.110 | |
| Total Series D preferred stock dividends | | $ | 76.735 | |
| | | | | | |
(1)The dividend includes $30.63 semi-annual dividend per depositary share plus $15.48 to account for the long first dividend period.
Our Board of Directors approved a new share repurchase program in April 2022. The new program authorizes up to $4.2 billion of share repurchases through June 30, 2023. This share repurchase authorization replaced a $2.4 billion share repurchase program, which expired on March 31, 2022. If and when we repurchase our shares under the program, we may use various methods, including open market purchases, privately negotiated transactions or other purchases, including block trades, accelerated share repurchase transactions, or any combination of such methods. During the three months ended June 30, 2022, we repurchased approximately 6 million shares for approximately $600 million. During the six months ended June 30, 2022, we repurchased approximately 14 million shares for approximately $1.5 billion.
The amount and size of any future dividends and share repurchases will depend on our results of operations, financial condition, capital levels, cash requirements, future prospects, regulatory review and other factors. We have suspended until further notice our existing share repurchase program because of an internal investigation relating to our student loan servicing practices and related compliance matters. The investigation is ongoing and is being conducted by a board-appointed independent special committee. The declaration and payment of future dividends and the amount thereof are subject to the discretion of our Board of Directors. Holders of our shares of common stock are subject to the prior dividend rights of holders of our preferred stock or the depositary shares representing such preferred stock outstanding. No dividend may be declared or paid or set aside for payment on our common stock if full dividends have not been declared and paid on all outstanding shares of preferred stock in any dividend period. In addition, as noted above, banking laws and regulations and our banking regulators may limit our ability to pay dividends and make share repurchases, including limitations on the extent our banking subsidiary (Discover Bank) can provide funds to us through dividends, loans or otherwise. Further, current or future regulatory reforms may require us to hold more capital or could adversely impact our capital level. As a result, there can be no assurance that we will declare and pay any dividends or repurchase any shares of our common stock in the future.