Discover Financial Services - Annual Report: 2019 (Form 10-K)

☒	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

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Part I | Item 1.	Business

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•	Discover it card offers 5% Cashback Bonus in categories that change each quarter up to a quarterly maximum and 1% Cashback Bonus on all other purchases.

•	Discover it Chrome card offers 2% Cashback Bonus at gas stations and restaurants on up to $1,000 in combined purchases each quarter and 1% Cashback Bonus on all other purchases.

•	Discover it Miles card offers 1.5 miles for every dollar spent on purchases.

•	Discover it Business card offers 1.5% Cashback Bonus on all purchases.

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•	Discover More card, which we no longer offer for new accounts, offers 5% Cashback Bonus in categories that change each quarter up to a quarterly maximum. Customers earn .25% Cashback Bonus on their first $3,000 on all other annual purchases and on all warehouse purchases, and 1% Cashback Bonus on purchases over $3,000.

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Identity Theft Protection. The identity theft monitoring product includes an initial credit report, credit bureau report monitoring at the three major credit bureaus, prompt alerts to key changes to credit bureau files that help customers spot possible identity theft quickly, internet surveillance to monitor multiple credit and debit card numbers and social security numbers on suspicious websites, identity theft insurance of $1,000,000 to cover certain out-of-pocket expenses due to identity theft, and access to knowledgeable professionals who can help resolve issues.

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Payment Protection. This product allows customers to suspend their minimum payments due for up to two years, depending on the qualifying event and product level, when certain qualifying life events occur. While on benefit, customers have no minimum monthly payment, and are not charged interest, late fees or the fees for the product. This product covers a variety of different events, such as unemployment, disability, natural disasters or other life events, such as marriage or birth of a child. Depending on the product level and availability under state laws, outstanding balances up to $10,000 or $25,000, are cancelled in the event of death.

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Wallet Protection. This product offers one-call convenience if a customer’s wallet is lost or stolen, including requesting cancellation and replacement of the customer’s credit and debit cards, monitoring the customer’s credit bureau reports at the three major credit bureaus for 180 days and alerting them to key changes to their credit files, and providing up to $100 to replace the customer’s wallet or purse.

•	Access to overall credit health tools such as Credit Scorecard, Freeze it, Social Security Number Alerts and New Account Alerts;

•	Customer service via multiple communication channels, including 24/7 customer service by telephone and messaging; and

•	Proactive notifications via email, text messaging and in-app messaging for monitoring transaction activity and account security.

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Item 1A.	Risk Factors

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•	Security attacks can originate from a wide variety of sources and geographic locations and may be undetected for a period of time.

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We rely on many third-party service providers and network participants, including merchants, and, as such, a security breach or cyber-attack affecting one of these third parties could impact us. For example, the financial services industry continues to see attacks against the environments where personal and identifiable information is handled. For additional information see the risk factor “— We rely on third parties to deliver

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•	To access our products and services, our customers may use computers and mobile devices that are beyond our security control systems.

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•	changes in economic variables, such as the availability of consumer credit, the housing market, energy costs, the number and size of personal bankruptcy filings, the rate of unemployment, the levels of consumer confidence and consumer debt, and investor sentiment;

•	the impact of current, pending and future legislation, regulation, supervisory guidance, and regulatory and legal actions, including, but not limited to, those related to accounting guidance, tax reform, financial regulatory reform, consumer financial services practices, anti-corruption and funding, capital and liquidity;

•	the actions and initiatives of current and potential competitors;

•	our ability to manage our expenses;

•	our ability to successfully achieve card acceptance across our networks and maintain relationships with network participants and merchants;

•	our ability to sustain and grow our card, private student loan and personal loan products;

•	our ability to increase or sustain Discover card usage or attract new customers;

•	difficulty obtaining regulatory approval for, financing, closing, transitioning, integrating or managing the expenses of acquisitions of or investments in new businesses, products or technologies;

•	our ability to manage our credit risk, market risk, liquidity risk, operational risk, compliance and legal risk, and strategic risk;

•	the availability and cost of funding and capital;

•	access to deposit, securitization, equity, debt and credit markets;

•	the impact of rating agency actions;

•	the level and volatility of equity prices, commodity prices and interest rates, currency values, investments, other market fluctuations and other market indices;

•	losses in our investment portfolio;

•	limits on our ability to pay dividends and repurchase our common stock;

•	limits on our ability to receive payments from our subsidiaries;

•	fraudulent activities or material security breaches of our or others’ key systems;

•	our ability to remain organizationally effective;

•	the effect of political, economic and market conditions, geopolitical events and unforeseen or catastrophic events;

•	our ability to introduce new products or services;

•	our ability to manage our relationships with third-party vendors;

•	our ability to maintain current technology and integrate new and acquired systems and technology;

•	our ability to collect amounts for disputed transactions from merchants and merchant acquirers;

•	our ability to attract and retain employees;

•	our ability to protect our reputation and our intellectual property; and

•	new lawsuits, investigations or similar matters or unanticipated developments related to current matters.

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Item 1B.	Unresolved Staff Comments

Item 2.	Properties

Item 3.	Legal Proceedings

Item 4.	Mine Safety Disclosures

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Part II | Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

(1)	On July 18, 2019, our Board of Directors approved a share repurchase program authorizing the purchase of up to $2.2 billion of our outstanding shares of common stock. This share repurchase program expires on September 30, 2020 and may be terminated at any time.

(2)	Reflects shares withheld (under the terms of grants under employee stock compensation plans) to offset tax withholding obligations that occur upon the delivery of outstanding shares underlying restricted stock units or upon the exercise of stock options.

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Item 6.	Selected Financial Data

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Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations

•	Net income was $3.0 billion, or $9.08 per diluted share, compared to $2.7 billion, or $7.79 per diluted share, in the prior year.

•	Total loans grew $5.4 billion, or 6%, to $95.9 billion.

•	Credit card loans grew $4.3 billion, or 6%, to $77.2 billion.

•	The total net charge-off rate increased 11 basis points to 3.17%.

•	The net charge-off rate for credit card loans increased 17 basis points to 3.43% and the delinquency rate for credit card loans over 30 days past due increased 19 basis points to 2.62%.

•	Direct-to-consumer deposits grew $9.7 billion, or 22%, to $54.4 billion.

•	Payment Services transaction volume for the segment was $251.4 billion, up 8%.

•	We continue to focus on disciplined capital deployment through profitable organic loan growth and execution of our capital plan.

•	Our marketing strategy is focused on adding new accounts to achieve continued loan growth. For credit cards, we are also focused on increasing utilization with existing customers.

•	Total expenses are expected to increase reflecting continued investment in brand awareness and technological capabilities.

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•	We will continue to pursue payments volume growth and leverage our network to support our card-issuing business.

•	We expect the total net charge-off rate to increase primarily due to the seasoning of recent loan growth.

•	Adoption of the current expected credit loss (“CECL”) approach will increase the allowance for loan losses. Going forward, the seasonality of our business will likely impact quarterly reserve changes and could increase volatility from one quarter to the next.

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(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.

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•	The level and composition of loan receivables, including the proportion of credit card loans to other loans, as well as the proportion of loan receivables bearing interest at promotional rates as compared to standard rates;

•	The credit performance of our loans, particularly with regard to charge-offs of finance charges, which reduce interest income;

•	The terms of long-term borrowings and certificates of deposit upon initial offering, including maturity and interest rate;

•	The interest rates necessary to attract and maintain direct-to-consumer deposits;

•	The level and composition of other interest-earning assets, including our liquidity portfolio and interest-bearing liabilities;

•	Changes in the interest rate environment, including the levels of interest rates and the relationships among interest rate indices, such as the prime rate, the Federal Funds rate, interest rate on excess reserves and LIBOR;

•	The effectiveness of interest rate swaps in our interest rate risk management program; and

•	The difference between the carrying amount and future cash flows expected to be collected on purchased credit-impaired (“PCI”) loans.

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(1)	Average balances of loan receivables include non-accruing loans, which are included in the yield calculations. If the non-accruing loan balances were excluded, there would not be a material impact on the amounts reported above.

(2)	Interest income on credit card loans includes $281 million, $241 million and $218 million of amortization of balance transfer fees for the years ended December 31, 2019, 2018 and 2017, respectively.

(3)	Includes the impact of interest rate swap agreements used to change a portion of fixed-rate funding to floating-rate funding.

(4)	Includes the impact of interest rate swap agreements used to change a portion of floating-rate funding to fixed-rate funding.

(5)	Includes the impact of Federal Deposit Insurance Corporation (“FDIC”) insurance premiums and Large Institution Surcharge. As of October 2018, the FDIC no longer assesses a Large Institution Surcharge.

(6)	Net interest margin represents net interest income as a percentage of average total loan receivables.

(7)	Net yield on interest-earning assets represents net interest income as a percentage of average total interest-earning assets.

(8)	Interest rate spread represents the difference between the rate on total interest-earning assets and the rate on total interest-bearing liabilities.

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(1)	The rate/volume variance for each category has been allocated on a consistent basis between rate and volume variances between the years ended December 31, 2019, 2018 and 2017 based on the percentage of the rate or volume variance to the sum of the two absolute variances.

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(1)	Represents PCI private student loans. See Note 4: Loan Receivables to our consolidated financial statements for more information regarding PCI loans.

•	The impact of general economic conditions on the consumer, including national and regional conditions, unemployment levels, bankruptcy trends and interest rate movements;

•	Changes in consumer spending, payment and credit utilization behaviors;

•	Changes in our loan portfolio, including the overall mix of accounts, products and loan balances within the portfolio and maturation of the loan portfolio;

•	The level and direction of historical and anticipated loan delinquencies and charge-offs;

•	The credit quality of the loan portfolio, which reflects, among other factors, our credit granting practices and effectiveness of collection efforts; and

•	Regulatory changes or new regulatory guidance.

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(1)	Includes both PCI and non-PCI private student loans.

(1)	See Note 4: Loan Receivables to our consolidated financial statements for information regarding the accounting for charge-offs on PCI loans.

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(1)	Excludes PCI loans, which are accounted for on a pooled basis. Since a pool is accounted for as a single asset with a single composite interest rate and aggregate expectation of cash flows, the past-due status of a pool, or that of the individual loans within a pool, is not meaningful. Because we are recognizing interest income on a pool of loans, it is all considered to be performing.

(2)	Restructured credit card loans include $184 million, $124 million, $74 million, $60 million and $44 million at December 31, 2019, 2018, 2017, 2016 and 2015, respectively, which are also included in loans 90 or more days delinquent.

(3)	Restructured personal loans include $7 million, $6 million, $5 million, $2 million and $4 million at December 31, 2019, 2018, 2017, 2016 and 2015, respectively, which are also included in loans 90 or more days delinquent.

(4)	Restructured private student loans include $10 million, $7 million, $5 million, $3 million and $3 million at December 31, 2019, 2018, 2017, 2016 and 2015, respectively, which are also included in loans 90 or more days delinquent.

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(1)	Because of the uncertainty regarding loan repayment patterns, the above amounts have been calculated using contractually required minimum payments. Historically, actual loan repayments have been higher than such minimum payments and, therefore, the above amounts may not necessarily be indicative of our actual loan repayments.

(1)	Net of rewards, including Cashback Bonus rewards, of $1.9 billion, $1.8 billion and $1.6 billion for the years ended December 31, 2019, 2018 and 2017, respectively.

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(1)	See Note 3: Investments — Other Investments to our consolidated financial statements for a description of these investments.

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(1)	An “sf” in the rating denotes rating agency identification for structured finance product ratings.

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(1)	Cash in the process of settlement and restricted cash are excluded from cash and cash equivalents for liquidity purposes.

(2)	Excludes $121 million and $42 million of U.S. Treasury securities that have been pledged as swap collateral in lieu of cash as of December 31, 2019 and 2018, respectively.

(3)	See “— Additional Funding Sources” for additional information.

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(1)	Total common stockholders’ equity is calculated as total stockholders’ equity less preferred stock.

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(1)	Deposits do not include interest payments because payment amounts and timing cannot be reasonably estimated as certain deposit accounts have early withdrawal rights and the option to roll interest payments into the balance.

(2)	Deposits due in less than one year include deposits with indeterminate maturities.

(3)	See Note 9: Long-Term Borrowings to our consolidated financial statements for further discussion. Total future payment of interest charges for the floating-rate notes is estimated to be $392 million as of December 31, 2019, utilizing the current interest rates as of that date.

(4)

Purchase obligations for goods and services include payments under, among other things, consulting, outsourcing, data, advertising, sponsorship, software license, telecommunications agreements and global acceptance contracts. Purchase obligations also include payments under rewards program agreements with merchants. Purchase obligations at December 31, 2019 reflect the minimum purchase obligation under legally binding contracts with contract terms that are both fixed and determinable. These amounts exclude obligations for goods and services that already have been incurred and are reflected on our consolidated statement of financial condition.

(5)	Other liabilities include our expected benefit payments associated with our pension plan, the contingent liability associated with our other investments accounted for under the equity method and a commitment to purchase certain when-issued mortgage-backed securities under an agreement with the Delaware State Housing Authority as part of our community reinvestment initiatives.

Item 7A.	Quantitative and Qualitative Disclosures About Market Risk

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Item 8.	Financial Statements and Supplementary Data

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•	We tested the design and operating effectiveness of management’s controls over the allowance for loan losses including controls over data integrity and model assumptions.

•	We tested the completeness and accuracy of the historical borrower data, including collection data, bankruptcy statistics, portfolio characteristics, and other data used in management’s models.

•	We used our credit modeling specialists to assist us in evaluating the appropriateness of the models used to determine the allowance. We also evaluated the reasonableness of the economic assumptions used in the models by comparing such assumptions to independent sources.

•	We evaluated the model results considering economic conditions, including recent trends in national credit card loan delinquencies and charge-offs data, and performed a peer analysis to evaluate the trends in the Company’s allowance for loan losses over time and as compared to its peers.

•	We assessed the reasonableness of the model results by comparing modeled losses to actual historical losses.

•	We tested the design and operating effectiveness of management’s controls over the CECL estimate including controls over data integrity, model assumptions and model validation.

•	We evaluated the Company’s accounting policies, methodologies, and elections involved in the adoption of the CECL model.

•	We tested the completeness and accuracy of the historical borrower data, including collection data, bankruptcy statistics, portfolio characteristics, and other data used in management’s models.

•	We used our credit modeling specialists to assist us in evaluating the appropriateness of the models used to determine the CECL estimate and examine logic for selected components of the model.

•	We also evaluated the reasonableness of the economic assumptions used in the models by comparing such assumptions to independent sources.

•	We evaluated the reasonable and supportable forecast period over which the key economic assumptions are applied, by reviewing the historical accuracy of economic forecasts and other underlying economic information management used as the basis for the selected reasonable and supportable period.

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•	For the credit card loan portfolio, we evaluated the assumption of how expected credit card payments are applied to existing credit card balances to determine if it is reasonable and consistent with the CECL standard. We used our credit modeling specialists to evaluate if the approach was consistently applied in the model in accordance with the Company’s selected policy.

•	We evaluated the completeness of the Company’s disclosures related to adoption of ASU 2016-13.

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1.	Background and Basis of Presentation

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•	A $2.5 billion increase to the allowance for loan losses primarily representing the adjustment for recording reserves for expected losses, not simply those deemed to be already incurred, and extending the loss estimate period over the entire life of the loan;

•	A $0.6 billion increase to other assets related to deferred tax assets on the larger allowance for loan losses;

•	An offsetting $1.9 billion decrease, net of tax, to the opening balance of retained earnings; and

•	Immaterial adjustments to the following:

◦	The carrying value of PCD loans and related accrued interest reflected in other assets; and

◦	Accrued expenses and other liabilities to record reserves for unfunded commitments.

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2.	Summary of Significant Accounting Policies

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3.	Investments

(1)	Includes $121 million and $42 million of U.S. Treasury securities pledged as swap collateral as of December 31, 2019 and 2018, respectively.

(2)	Consists of residential mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae.

(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 that were classified as held-to-maturity as they were entered into as a part of the Company’s community reinvestment initiatives.

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(1)	Maturities of residential mortgage-backed securities are reflective of the contractual maturities of the investment.

(1)	The weighted-average yield for available-for-sale investment securities is calculated based on the amortized cost.

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4.	Loan Receivables

(1)	Amounts include carrying values of $18.9 billion and $22.0 billion underlying investors’ interest in trust debt at December 31, 2019 and 2018, respectively, and $12.7 billion and $11.1 billion in seller’s interest at December 31, 2019 and 2018, respectively. See Note 5: Credit Card and Student Loan Securitization Activities for additional information.

(2)	Amounts include carrying values of $292 million and $363 million in loans pledged as collateral against the note issued from a student loan securitization trust at December 31, 2019 and 2018, respectively. See Note 5: Credit Card and Student Loan Securitization Activities for additional information.

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(1)

The Company estimates that the gross interest income that would have been recorded in accordance with the original terms of non-accruing credit card loans was $45 million, $41 million and $35 million for the years ended December 31, 2019, 2018 and 2017, respectively. The Company does not separately track the amount of gross interest income that would have been recorded in accordance with the original terms of loans. This amount was estimated based on customers’ current balances and most recent interest rates.

(2)	Credit card loans that are 90 or more days delinquent and accruing interest include $175 million and $116 million of loans accounted for as TDRs at December 31, 2019 and 2018, respectively.

(3)	Personal loans that are 90 or more days delinquent and accruing interest include $7 million and $5 million of loans accounted for as TDRs at December 31, 2019 and 2018, respectively.

(4)	Private student loans that are 90 or more days delinquent and accruing interest include $10 million and $7 million of loans accounted for as TDRs at December 31, 2019 and 2018, respectively.

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(1)	Net charge-off rate represents net charge-off dollars (annualized) divided by average loans for the reporting period.

(1)	PCI loans are discussed under the heading “— Purchased Credit-Impaired Loans.”

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(1)	Includes both PCI and non-PCI private student loans.

(2)	Net change in reserves on PCI pools having no remaining non-accretable difference.

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(1)	Includes both PCI and non-PCI private student loans.

(2)	Loan receivables evaluated for impairment in accordance with ASC 310-10-35 include credit card loans, personal loans and student loans collectively evaluated for impairment in accordance with ASC Subtopic 310-40, Receivables, which consists of modified loans accounted for as TDRs. Other loans are individually evaluated for impairment and generally do not represent TDRs.

(3)	The unpaid principal balance of credit card loans was $3.0 billion and $2.0 billion at December 31, 2019 and 2018, respectively. All loans accounted for as TDRs have a related allowance for loan losses.

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(1)	The Company does not separately track interest income on loans in modification programs. Amounts shown are estimated by applying an average interest rate to the average loans in the various modification programs.

(2)

The Company does not separately track the amount of additional gross interest income that would have been recorded if the loans in modification programs had not been restructured and interest had instead been recorded in accordance with the original terms. Amounts shown are estimated by applying the difference between the average interest rate earned on non-impaired loans and the average interest rate earned on loans in the modification programs to the average loans in the modification programs.

(3)

Includes credit card loans that were modified in TDRs, but are no longer enrolled in a TDR program due to noncompliance with the terms of the modification or due to successful completion of a program after which charging privileges may be reinstated based on customer-level evaluation. The average balance of credit card loans that were no longer enrolled in a TDR program was $916 million, $430 million and $339 million, respectively, for the years ended December 31, 2019, 2018 and 2017.

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(1)	Terms revert back to the pre-modification terms for customers who default from a temporary program and charging privileges remain revoked in most cases.

(2)	For credit card loans and personal loans, a customer defaults from a modification program after two consecutive missed payments. The outstanding balance upon default is generally the loan balance at the end of the month prior to default.

(3)	For student loans, defaults have been defined as loans that 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.

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5.	Credit Card and Student Loan Securitization Activities

(1)	The Company maintains its allowance for loan losses at an amount sufficient to absorb probable losses inherent in all loan receivables, which includes all loan receivables in the trusts. Therefore, credit risk associated with the transferred receivables is fully reflected on the Company’s balance sheet in accordance with GAAP.

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6.	Premises and Equipment

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7.	Goodwill and Intangible Assets

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8.	Deposits

(1)	Includes $2.6 billion and $1.7 billion in certificates of deposit equal to or greater than $250,000, the Federal Deposit Insurance Corporation (“FDIC”) insurance limit, as of December 31, 2019 and 2018, respectively.

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9.	Long-Term Borrowings

(1)	The Company uses interest rate swaps to hedge portions of these long-term borrowings against changes in fair value attributable to changes in London Interbank Offered Rate (“LIBOR”) or Overnight Index Swap (“OIS”) Rate. Use of these interest rate swaps impacts carrying value of the debt. See Note 21: Derivatives and Hedging Activities.

(2)	Discover Card Execution Note Trust floating-rate asset-backed securities include issuances with the following interest rate terms: 1-month LIBOR + 23 to 60 basis points and Commercial paper rate + 55 basis points as of December 31, 2019.

(3)	The Company uses interest rate swaps to manage its exposure to changes in interest rates related to future cash flows resulting from interest payments on a portion of these long-term borrowings. There is no impact on debt carrying value from use of these interest rate swaps. See Note 21: Derivatives and Hedging Activities.

(4)	The student loan securitization trust floating-rate asset-backed security includes an issuance with the following interest rate term: Prime rate + 100 basis points as of December 31, 2019.

(5)	Repayment of this debt is dependent upon the timing of principal and interest payments on the underlying student loans. The date shown represents final maturity date.

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10.	Stock-Based Compensation Plans

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(1)	Unvested RSUs represent awards where recipients have yet to satisfy either explicit vesting terms or retirement-eligibility requirements.

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(2)	Includes 243,100 PSUs granted in 2017 that are earned based on the Company’s achievement of earnings per share (“EPS”) during the three-year performance period which ends December 31, 2019 and are subject to the requisite service period which ended February 1, 2020.

(3)	Includes 246,503 PSUs granted in 2018 that are earned based on the Company’s achievement of EPS during the three-year performance period which ends December 31, 2020 and are subject to the requisite service period which ends February 1, 2021.

(4)	Includes 233,930 PSUs granted in 2019 that may be earned based on the Company’s achievement of EPS during the three-year performance period which ends December 31, 2021 and are subject to the requisite service period which ends February 1, 2022.

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11.	Employee Benefit Plans

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12.	Common and Preferred Stock

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13.	Accumulated Other Comprehensive Income

(1)	Represents the adjustment to AOCI as a result of adoption of ASU No. 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, in the second quarter of 2018.

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14.	Other Expense

15.	Income Taxes

(1)	See Note 3: Investments — Other Investments for a description of these investments.

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(1)	For the years ended December 31, 2019, 2018 and 2017, amounts included $54 million, $74 million and $105 million, respectively, of unrecognized tax benefits, which, if recognized, would favorably affect the effective tax rate.

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16.	Earnings Per Share

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17.	Capital Adequacy

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(1)	Capital ratios are calculated based on the Basel III Standardized Approach rules, subject to applicable 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.

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18.	Commitments, Contingencies and Guarantees

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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.

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•	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.

•	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.

(1)	Represents transactions processed on the Discover Network for which a potential liability exists that, in aggregate, can differ from credit card sales volume.

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19.	Litigation and Regulatory Matters

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20.	Fair Value Measurements

•	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.

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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.

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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 in which the inputs used to measure fair value may fall into different levels of the fair value hierarchy, the level in the fair value hierarchy within which the fair value measurement in its entirety is classified is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company may utilize both observable and unobservable inputs in determining the fair values of financial instruments classified within the Level 3 category.

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(1)	Derivative instrument carrying values in an asset or liability position are presented as part of other assets or accrued expenses and other liabilities, respectively, in the Company’s consolidated statements of financial condition.

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(1)	The carrying values of these assets and liabilities approximate fair value due to the nature of their liquidity (i.e., due or payable in less than one year).

(2)	Accrued interest receivable and payable carrying values are presented as part of other assets or accrued expenses and other liabilities, respectively, in the Company’s consolidated statements of financial condition.

(3)	Excludes deposits without contractually defined maturities for all periods presented.

21.	Derivatives and Hedging Activities

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(1)	The foreign exchange forward contracts have notional amounts of EUR 9 million, GBP 14 million, SGD 1 million and INR 596 million as of December 31, 2019 and notional amounts of EUR 9 million, GBP 12 million, SGD 1 million and INR 464 million as of December 31, 2018.

(2)

In addition to the derivatives disclosed in the table, the Company enters into forward contracts to purchase when-issued mortgage-backed securities as part of its community reinvestment initiatives. At December 31, 2019, the Company had two outstanding contracts with a total notional amount of $42 million and immaterial fair value. At December 31, 2018, the Company had one outstanding contract with a notional amount of $79 million and immaterial fair value.

(3)	Collateral amounts, which consist of both cash and investment securities, are limited to the related derivative asset/liability balance and do not include excess collateral received/pledged.

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22.	Segment Disclosures

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Direct Banking: The Direct 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 equity loans, and other consumer lending and deposit products. The majority of Direct 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.

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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 Company aggregates operating segments when determining reportable segments.

•	Corporate overhead is not allocated between segments; all corporate overhead is included in the Direct Banking segment.

•	Through its operation of the Discover Network, the Direct Banking segment incurs fixed marketing, servicing and infrastructure costs that are not specifically allocated among the segments, with the exception of an allocation of direct and incremental costs driven by the Company’s Payment Services segment.

•	The assets of the Company 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.

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23.	Revenue from Contracts with Customers

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(1)	Net of rewards, including Cashback Bonus rewards, of $1.9 billion, $1.8 billion and $1.6 billion for the years ended December 31, 2019, 2018 and 2017, respectively.

(2)	Excludes $3 million, $3 million and $2 million deposit product fees that are reported within net interest income for the years ended December 31, 2019, 2018 and 2017, respectively.

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24.	Related Party Transactions

25.	Parent Company Condensed Financial Information

(1)	The Parent Company had $2.4 billion and $1.4 billion in a money market deposit account at Discover Bank as of December 31, 2019 and 2018, respectively, which is included in cash and cash equivalents. These funds are available to the Parent for liquidity purposes.

(2)	The Parent Company advanced $500 million to Discover Bank as of December 31, 2019 and 2018, which is included in notes receivable from subsidiaries. These funds are available to the Parent for liquidity purposes.

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26.	Subsequent Events

27.	Quarterly Results

(1)	Because the inputs to net income allocated to common stockholders and earnings per share are calculated using weighted averages for the quarter, the sum of all four quarters may differ from the year to date amounts in the consolidated statements of income.

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Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Item 9A.	Controls and Procedures

Item 9B.	Other Information

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Part III | Item 10.	Directors, Executive Officers and Corporate Governance

Item 11.	Executive Compensation

Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

(1)	Includes 2,148,976 vested and unvested restricted stock units and 723,533 vested and unvested performance stock units that can be converted to up to 1.5 shares per each unit dependent on the performance factor.

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Item 13.	Certain Relationships and Related Transactions, and Director Independence

Item 14.	Principal Accounting Fees and Services

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Part IV | Item 15.	Exhibits, Financial Statement Schedules

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*	We agree to furnish supplementally to the Commission a copy of any omitted schedule or exhibit to such agreement upon the request of the Commission in accordance with Item 601(b)(2) of Regulation S-K.

†	Management contract or compensatory plan or arrangement required to be filed as an exhibit to Form 10-K pursuant to Item 15(b) of this report.

Item 16.	Form 10-K Summary

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