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Article by DailyStocks_admin    (10-13-08 08:53 AM)

Discover Financial Services. CEO DAVID W NELMS bought 20000 shares on 10-03-2008 at $12.09

BUSINESS OVERVIEW

Introduction

We are a leading credit card issuer and electronic payment services company with one of the most recognized brands in U.S. financial services. Since our inception in 1986, we have grown to become one of the largest card issuers in the United States with $48.2 billion in managed receivables as of November 30, 2007. We are also a leader in payments processing, as we are one of only two credit card issuers with its own U.S. payments network and the only issuer whose wholly-owned network operations include both credit and debit functionality. In 2007, we processed 3.8 billion transactions through our signature card network (the “Discover Network”) and PULSE EFT Association (the “PULSE Network” or “PULSE”), one of the nation’s leading ATM/debit networks.

We issue credit cards in the United States under the Discover Card brand to various segments within the consumer and small business sectors. Most of our cards offer a Cashback Bonus rewards program. In addition, we offer a range of banking products to our customers, including personal loans, student loans, certificates of deposit and money market accounts.

Discover Network cards currently are accepted at millions of merchant and cash access locations primarily in the United States, Mexico, Canada and the Caribbean. In October 2004, the U.S. Department of Justice (“DOJ”) prevailed in its antitrust lawsuit (the “DOJ litigation”) against Visa U.S.A., Inc. (together with its predecessors, “Visa”) and MasterCard Worldwide (together with its predecessors, “MasterCard”) which challenged their exclusionary rules—rules that effectively precluded us from offering network services to financial institutions. Since then, we have accelerated our network growth by entering the debit market with the acquisition of the PULSE Network, and by signing card issuing agreements with a number of financial institutions. We also have significantly expanded our relationships with companies that provide merchants with credit card processing services, which we believe will further increase the number of merchants accepting Discover Network cards.

In addition, we issue credit cards on the MasterCard and Visa networks in the United Kingdom, the world’s second-largest credit card market. Our portfolio includes Goldfish, one of the United Kingdom’s leading rewards credit cards, as well as several Morgan Stanley-branded credit cards and a number of affinity credit cards. As of November 30, 2007, we had $4.4 billion of managed receivables in the United Kingdom. On February 7, 2008, we entered into an agreement to sell our credit card business in the United Kingdom to Barclay’s Bank Plc. The closing is expected to occur by the end of our second quarter of 2008 and is subject to the satisfaction of a number of conditions. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Sale of International Card Segment; First Quarter 2008 Charge” for more information relating to the sale of our Goldfish business.

Our revenues (net interest income plus other income) have increased over the last three years, from $4.3 billion in 2005 to $5.1 billion in 2007, and net income was $589 million (which included a non-cash impairment charge of $279 million after tax related to our credit card business in the United Kingdom, also referred to as the Goldfish business), $1.1 billion, and $578 million for the years ended November 30, 2007, 2006 and 2005, respectively. For additional financial information relating to our business and our operating segments, see Note 23: Segment Disclosures to the consolidated and combined financial statements and for additional financial information concerning our geographic regions, see Note 25: Geographical Distribution of Loans to the consolidated and combined financial statements.

On June 30, 2007, we were spun-off from our former parent company, Morgan Stanley, through the distribution of our shares to its shareholders (the “Distribution”). We became a subsidiary of Morgan Stanley in May 1997 as a result of the combination of Dean Witter, Discover & Co. and Morgan Stanley Group, Inc. The entity currently named Discover Financial Services was a subsidiary of Sears, Roebuck and Co. (“Sears”) from 1960 until 1993, when it was part of the spin-off of Dean Witter Financial Services Group Inc. from Sears. The Discover Card business was launched in 1986.

We were incorporated in Delaware in 1960. Our principal executive offices are located at 2500 Lake Cook Road, Riverwoods, Illinois 60015. Our main telephone number is (224) 405-0900.

Available Information

We are required to file current, annual and quarterly reports, proxy statements and other information required by the Securities Exchange Act of 1934, as amended (the “Exchange Act”), with the SEC. You may read and copy any document we file with the SEC at the SEC’s Public Reference Room located at 100 F Street, N.E., Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an internet website at http://www.sec.gov , from which interested persons can electronically access our SEC filings.

We will make available free of charge through our internet site http://www.discover.com , our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements, Forms 3, 4 and 5 filed by or on behalf of directors, executive officers and certain large stockholders, and any amendments to those documents filed or furnished pursuant to the Exchange Act. These filings will become available as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC.

We also make available, on the Investor Relations page of our website, our (i) Corporate Governance Policies, (ii) Code of Ethics and Business Conduct and (iii) the charter of the Audit, Compensation, and Nominating and Governance Committees of our Board of Directors. These documents will also be available in print without charge to any person who requests them by writing or telephoning: Discover Financial Services, Office of the Corporate Secretary, 2500 Lake Cook Road, Riverwoods, Illinois 60015, U.S.A., telephone number (224) 405-0900.

Operating Model

We operate in three reportable segments: U.S. Card, Third-Party Payments and International Card. On February 7, 2008, we announced that we had entered into a definitive sale and purchase agreement to sell our U.K. credit card business, which represents substantially all of the International Card segment, to Barclay’s Bank Plc. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Sale of International Card Segment; First Quarter 2008 Charge” for more information relating to the sale of our Goldfish business.

U.S. Card

From our inception in 1986 until October 2004, we operated as a “closed loop” credit card business in which we performed all functions related to our credit card business by acting as the card issuer, network and merchant acquirer. As a result of the resolution of the DOJ litigation, we recently began entering into agreements with a number of third-party merchant acquirers.

We issue Discover Cards through our wholly-owned subsidiary Discover Bank. Cardmembers are permitted to “revolve” their balances and repay their obligations over a period of time and at an interest rate set forth in their cardmember agreements, which may be either fixed or variable. The interest that we earn on revolving balances is our primary source of revenue from cardmembers. We finance these balances using a variety of debt instruments, including securitizations, from which we derive a significant portion of our income. We also charge cardmembers other fees, including fees for late payment and for exceeding credit limits. In addition, we receive fees from merchants or merchant acquirers based on sales volume charged to Discover Network cards. We recognize rewards cost as a reduction of discount and interchange revenue.

Where we have a direct relationship with the merchant, which is the case with respect to our large merchants that represent a majority of Discover Card sales volume, we receive discount and fee revenue from merchants. Discount and fee revenue is based on pricing that varies due to a number of factors including industry, special marketing arrangements, competitive pricing levels and size of merchant.

Where we do not have a direct relationship with the merchant, we receive interchange and assessment fees from the merchant acquirer that settles transactions with the merchant. The amount of this fee is based on a standardized schedule and can vary based on the type of merchant or type of card (e.g., consumer vs. business).

We also offer various products and services, such as Payment Protection, Identity Theft Protection, Wallet Protection, Credit ScoreTracker and other cross-sell and fee-based products to our existing customer base.

Third-Party Payments

Our payments business includes the PULSE Network, as well as financial institutions that issue credit, debit and prepaid cards on the Discover Network. When a financial institution joins the PULSE Network, debit cards issued by that institution can be used at all of the ATMs and PIN point-of-sale debit terminals that participate in the network, and the PULSE mark can be used on that institution’s debit cards and ATMs. In addition, financial institution participants may sponsor merchants and independent sales organizations to participate in the network’s PIN POS and ATM debit service. A participating financial institution assumes liability for transactions initiated through the use of debit cards issued by that institution, as well as for ensuring compliance with PULSE’s operating rules and policies applicable to that institution’s debit cards, ATMs and, if applicable, sponsored merchants and independent sales organizations. PULSE derives its revenue from switch fees paid for PIN POS and ATM transactions routed to the PULSE Network for authorization, as well as membership and other fees paid by participants in the network. We earn merchant discount and acquirer interchange revenue, net of issuer interchange paid, plus assessments and fees for processing transactions for third-party issuers of credit cards on the Discover Network.

International Card

Our international card issuing business differs from our U.S. card business in that we rely on third-party networks, historically the MasterCard Network, and more recently, as a member of Visa Europe, the Visa Network. As a result, third parties maintain the relationships with merchants and pass customer charges on to our U.K. card issuing bank, Goldfish Bank Limited. As in the U.S. card business, we charge interest fees, late payment and overlimit fees and fees for various other products and services.

Marketing

The key functions performed in marketing include customer acquisition, product development, pricing and analytics, customer management, advertising and brand management, rewards/Cashback Bonus, fee products and website management.

Customer Acquisition

We seek creditworthy individuals by leveraging an integrated acquisition and risk management process. To acquire new customers, we use proprietary targeting and analytical models to identify attractive prospects and match them with our product offerings. We employ multiple acquisition channels, including direct mail, internet, print advertising, direct response television and telemarketing.

Direct mail has historically accounted for the greatest proportion of new accounts, representing approximately 50% of new accounts acquired in 2007. We focus on our account acquisition costs through product innovation, expanded creative testing, enhanced targeting/modeling and production efficiencies. Historically, telemarketing was also a significant channel but we have largely shifted to other channels such as internet-acquired accounts.

Product Development

We continue to develop card features and benefits to attract and retain cardmembers and merchants, such as our popular 5% Cashback Bonus program where cardmembers who sign up for this program earn 5% cash rewards in select retail categories. The category mix changes each quarter, allowing us to target different areas of cardmember spending each season, alert cardmembers to new places they can use their cards and manage our rewards costs.

We have also relaunched several card products, including our 5% Gas Card (now known as the Discover Open Road Card) and a redesigned Miles by Discover Card. In June 2006, we announced the launch of a small business credit card that offers cash rewards, distinctive control features and dedicated service. The Discover Motiva Card, launched in March 2007, provides cardmembers with a full month’s interest as a reward each time they make six consecutive on-time payments. In 2007, we launched personal loan and student loan products, as well as the Discover Insurance Center.

Pricing and Analytics

We use an analytical pricing strategy that provides competitive pricing for cardmembers and seeks to maximize revenue on a risk-adjusted basis. We assign specific annual percentage rates (APRs), fees and terms for different products and cardmembers, including purchases, balance transfers and cash advances. We periodically assess individual-level behavior practices and use risk models to determine appropriate pricing terms for our cardmembers, providing lower promotional rates for some customers while assessing higher rates for others who have demonstrated high-risk behaviors such as defaulting on their payments.

Customer Management

We actively work to increase sales and build loan balances of new and existing cardmembers by marketing to them through a variety of channels, including mail, phone and online. Targeted offers may include balance transfers, fee products and reinforcement of our Cashback Bonus rewards program.

We also continue to improve our modeling and customer engagement capabilities, which we believe will help us offer the right products and pricing at the right time and through the right channels. Recent enhancements include the development of a large prospect database, trade-line level data and a customer contact strategy and management system.

Advertising and Brand Management

We maintain a full-service, in-house marketing and communications department charged with delivering communications to foster customer engagement with our products and services. This helps us promote our brands, launch new products, supervise external agencies and provide integrated marketing communications.

Rewards /Cashback Bonus

Under our Cashback Bonus rewards program, we provide cardmembers with up to 1% Cashback Bonus , based upon their level and type of purchases. The amount of the Cashback Bonus generally increases as the cardmember’s purchases increase during the year. Cardmembers earn a full 1.0% once their total annual purchases exceed $3,000. Annual purchases up to $1,500 earn a 0.25% Cashback Bonus and purchases between $1,500 and $3,000 earn 0.50%. Purchases made at certain warehouse clubs or discount stores earn a fixed Cashback Bonus reward of 0.25%. Cardmembers can earn additional rewards by participating in periodic “5% Get More” promotions for select categories of merchants.

Cardmembers can choose from several card products that allow them to accelerate their cash rewards earnings based on how they want to use credit. For example, the Discover Open Road Card provides 5% Cashback Bonus on the first $100 in gas and auto maintenance purchases each billing period.

Cardmembers who are not delinquent or otherwise disqualified may redeem Cashback Bonus rewards at any time in increments of $20, and cardmembers have the option to choose a statement credit, direct deposit, partner gift card or charitable donation. When cardmembers choose to redeem their Cashback Bonus with one of our more than 100 merchant partners, they have the opportunity to increase their reward, up to double the reward amount.

Fee Products

We market several fee-based products to our cardmembers, including the following:


•

Identity Theft Protection . The most comprehensive identity theft monitoring service we offer includes an initial credit report, credit bureau file monitoring, prompt alerts that help cardmembers spot possible identity theft quickly, and access to knowledgeable professionals who can provide information about identity theft issues or credit reports.


•

Payment Protection . This service allows cardmembers to suspend their payments in the event of unemployment, disability or other life events for up to two years. In most states, any outstanding balance up to $25,000 is cancelled in the event of death.


•

Wallet Protection . This service offers one-call convenience if the cardmember’s wallet is lost or stolen, including requesting cancellation and replacement of the cardmember’s credit and debit cards, monitoring the cardmember’s credit files for 90 days, providing up to $100 to replace the cardmember’s wallet, and if needed, lending the cardmember up to $1,000 in emergency cash.


•

Credit ScoreTracker. A comprehensive credit score tracking product offering Discover cardmembers resources that help them understand and monitor their credit score. Credit ScoreTracker is specifically designed for score monitoring, alerting cardmembers when their score changes, allowing cardmembers to set a target score and providing resources to help them understand the factors that may be influencing their score.

Cardmember Website

Cardmembers can register their accounts online at Discover.com, which offers a range of benefits and control features that allow cardmembers to customize their accounts to meet their own preferences and needs. Key offerings include:


•

Online account services that allow cardmembers to customize their accounts, choose how and when they pay their bills, and create annual account summaries that assist with budgeting and taxes;


•

Email reminders to help cardmembers avoid fees and track big purchases or returns;

•

Secure online account numbers that let cardmembers shop online without ever revealing their actual account numbers; and


•

ShopDiscover, an online portal where cardmembers automatically earn 5–20% Cashback Bonus when they shop at well-known online merchants.

Credit Risk

Risk management is a critical and fully integrated component of our management and growth strategy. We have developed a risk management structure to manage credit and other risks facing our business.

Credit risk refers to the risk of loss arising from borrower default when a borrower is unable or unwilling to meet their financial obligations to Discover. Our credit risk is generally highly diversified across millions of accounts without significant individual exposures; accordingly, we manage risk on a portfolio basis. We have a risk committee that is composed of our senior management and is responsible for the establishment of criteria relating to risk management.

New Cardmembers

We subject all credit applications to an underwriting process that assesses the creditworthiness of each applicant. In terms of identifying potential cardmembers, we give consideration to the prospective cardmember’s financial stability, as well as ability and willingness to pay.

Prospective cardmembers’ applications are evaluated using credit information provided by the credit bureaus and other sources. Credit scoring systems, both externally developed and proprietary, are used to evaluate cardmember and credit bureau data. We assign credit lines to our cardmembers on the basis of risk level, income and expected card usage.

We use experienced credit underwriters to supplement our automated decision-making processes. Approximately 25% of all applications are subject to manual review that covers the areas of key cardmember data verification, fraud prevention and approval of higher credit lines. We periodically review policies, procedures and processes to ensure accurate implementation.

Portfolio Management

Proactive management of a cardmember’s account is a critical part of credit management, and all accounts are subject to ongoing credit assessment. This assessment reflects information relating to the performance of the individual’s Discover account as well as information from a credit bureau relating to the cardmember’s broader credit performance. This information is used as an integral part of credit decision-making as well as for management reporting purposes.

The measurement and management of credit risk is supported by scoring models (statistical evaluation models). At the individual cardmember level, we use custom risk models together with generic industry models as an integral part of the credit decision-making process.

Depending on the duration of the cardmember’s account, risk profile and other performance metrics, the account may be subject to a range of account management treatments, for example, eligibility for marketing initiatives, authorization, increases or decreases in retail and cash credit limits, pricing adjustments and delinquency strategies.

Cardmember Assistance

Authorizations . Each transaction is subject to screening and approval through a proprietary point-of-sale decision system. This system utilizes rules-based decision-making logic, statistical models and data integrity checks to manage fraud and credit risks. Strategies are subject to regular review and enhancement to enable us to respond quickly to changing credit conditions as well as to protect our cardmembers and the business from emerging fraud activity.

Proactive Account Management . We use a variety of collection and recovery strategies, with overdue delinquent accounts scored and segmented to tailor the collection approach. We employ predictive call campaigns, as well as offering payment programs for certain cardmembers to find customized solutions that fit their financial situation. We offer tools such as payment email reminders, flexible payment plans and a collections website designed to educate and assist cardmembers with their payment needs. Our payment plans are designed to help bring accounts out of delinquency or overlimit exposure.

Collections . All monthly billing statements of accounts with past due amounts include a request for payment of such amounts. These accounts also receive a written notice of late fee charges, as well as an additional request for payment, after the first monthly statement that reflects a past due amount. Collection personnel generally initiate contact with cardmembers within 30 days after any portion of their balance becomes past due. The nature and the timing of the initial contact, typically a personal call or letter, are determined by a review of the cardmember’s prior account activity and payment habits. For higher risk accounts, as determined by statistically derived predictive models, telephone contacts may begin as soon as the account becomes past due. Lower risk cardmembers are typically contacted by letter and further collection efforts are determined by behavioral scoring, financial exposure and the lateness of the payment.

We reevaluate our collection efforts and consider the implementation of other techniques as a cardmember becomes more days delinquent. We limit our exposure to delinquencies through controls within the authorizations system and criteria based account suspension and revocation. In situations involving a cardmember with financial difficulties, we may enter into arrangements to extend or otherwise change payment schedules.

Recovery . Credit card loans are charged-off at the end of the month during which an account becomes 180 days contractually past due. The only exceptions are bankrupt accounts, deceased customers, accounts on payment hardship or settlement programs and fraudulent transactions, which are charged off earlier.

We use various recovery techniques and channels that include internal collection activities, use of collections agencies, legal action and sales of charged-off accounts and the related receivables. The timing and choice of channel utilized are subject to a recovery optimization strategy that encompasses factors such as cost and duration against expected recovery effectiveness.

Fraud Prevention

We actively monitor cardmember accounts to prevent, detect, investigate and resolve fraud. Our fraud prevention processes are designed to protect the security of cards, applications and accounts in a manner consistent with our cardmembers’ needs to easily acquire and use our products. Prevention systems handle the authorization of application information, verification of cardmember identity, sales, processing of convenience and balance transfer checks and electronic transactions.

Our fraud detection program utilizes a variety of proven systems techniques to identify and halt fraudulent transactions, including neural and pattern recognition technology, rules-based decision-making logic, report analysis and manual account reviews. Accounts identified by the fraud detection system are managed by proprietary software that integrates effective fraud prevention with customer centric service.

Customer Service and Processing Services

Customer Service

We currently manage over 70 million annual inbound service calls placed to 1-800-Discover. We are committed to answering calls within 60 seconds or less and to providing “one-call resolution.”

We perform the functions required to service and operate cardmember credit accounts, including new account solicitation, application processing, new account fulfillment, transaction authorization and processing, cardmember billing, payment processing, cardmember service and collection of delinquent accounts. We believe that direct management of these functions reduces our customer attrition and is cost-effective.

Designed around customer and account manager needs, our technology and systems enable our account managers to quickly access information in a manner that supports accurate and timely resolution of inquiries. We develop and maintain our infrastructure solutions with the flexibility to change and adapt quickly to meet customer expectations and needs. In addition to our systems, we invest in our people, providing them with the training and work environment that facilitates their ability to build strong customer relationships.

Processing Services

Processing Services is composed of four functional areas: card personalization/embossing , print/mail, remittance processing and check/document processing. Card personalization/embossing is responsible for the embossing and mailing of plastic credit cards for new accounts, replacements and reissues, as well as gift cards. Print/mail specializes in statement and letter printing and mailing for merchants and cardmembers. Remittance processing handles account payments, check processing and product enrollments.

Technology

We provide technology systems processing through a combination of owned and hosted data centers. These data centers support our Discover and PULSE Networks, provide cardmembers with access to their accounts at all times and manage transaction authorizations, among other functions.

Our approach to technology development and management involves both third-party and in-house resources. We use third-party vendors for basic technology services (e.g., telecommunications, hardware and operating systems). Each vendor participates in a formal selection process to ensure that we have partners who can provide us with a cost-effective and reliable technology platform. This approach enables us to focus our in-house resources on building proprietary systems (e.g., for cardmember and merchant settlement, authorizations and customer relationship management) that we believe enhance our operations, improve cost efficiencies and help distinguish us in the marketplace.

Discover Card Terms and Conditions

The terms and conditions governing our products vary by product and change over time. Each cardmember enters into an agreement governing the terms and conditions of the cardmember’s account. Discover Card’s terms and conditions are generally uniform from state to state. The cardmember agreement permits us to change the credit terms, including the annual percentage rates and the fees imposed on accounts, with notice to the cardmember. The cardmember has the right to opt out of the change of terms and pay their balance off under the old terms. Each cardmember agreement provides that the account can be used for purchases, cash advances and balance transfers. Each Discover Card account is assigned a credit limit when the account is initially opened. Thereafter, individual credit limits may be increased or decreased from time to time, at our discretion, based primarily on our evaluation of the cardmember’s creditworthiness.

Discover Bank offers various features and services with the Discover Card accounts, including the Cashback Bonus reward described under “—Marketing—Rewards/Cashb ack Bonus.” A cardmember’s earned Cashback Bonus rewards are recorded in a “Cashback Bonus Account”; eligible cardmembers may redeem their rewards in increments of $20.

Discover Card accounts generally have the same billing and payment structure, though there are some differences between the consumer and business credit cards, as described below. Unless we waive the right to do so, we send a monthly billing statement to each cardmember who has an outstanding debit or credit balance. Cardmembers also can waive their right to receive a physical copy of their bill, in which case they will receive email notifications of the availability of their billing statement online at the Discover Card Account Center. Discover Card accounts are grouped into multiple billing cycles for operational purposes. Each billing cycle has a separate billing date, on which we process and bill to cardmembers all activity that occurred in the related accounts during the period of approximately 28 to 34 days that ends on that date.

We offer fixed and variable rates of periodic finance charges on accounts. Neither cash advances nor balance transfers are subject to a grace period. Periodic finance charges on purchases are calculated on a daily basis, subject to a grace period that essentially provides that periodic finance changes are not imposed if the cardmember pays his or her entire balance each month. Certain account balances, such as balance transfers, may accrue periodic finance charges at lower fixed rates for a specified period of time. Variable rates are indexed to the highest prime rate published in The Wall Street Journal on the last business day of the month.

Additional Consumer Card Terms . Each cardmember with an outstanding debit balance in his or her consumer Discover Card account must generally make a minimum payment each month. If a cardmember exceeds his or her credit limit as of the last day of the billing period, we may include all or a portion of this excess amount in the cardmember’s minimum monthly payment. From time to time, we have offered and may continue to offer eligible cardmembers the opportunity to not make the minimum monthly payment, while continuing to accrue periodic finance charges, without being considered past due. A cardmember may pay the total amount due at any time. We also may enter into arrangements with delinquent cardmembers to extend or otherwise change payment schedules, and to waive finance charges, fees and/or principal due, including re-aging accounts in accordance with regulatory guidance. Income may be reduced during any period in which we offer cardmembers the opportunity to not make the minimum monthly payment or to extend or change payment schedules.

In addition to periodic finance charges, we may impose other charges and fees on Discover Card accounts, including cash advance transaction fees, late fees where a cardmember has not made a minimum payment by the required due date, overlimit fees for balances that exceed a cardmember’s credit limit as of the close of the cardmember’s monthly billing cycle, balance transfer fees, returned check fees, pay-by-phone fees and fees for balance transfers or other promotional checks that are returned by us due to insufficient credit availability.

For most consumer cards we use the two-cycle billing method for determining periodic finance charges. This means if a cardmember begins a billing cycle with no outstanding balance, makes purchases or other transactions and then does not pay the outstanding balance in full by the payment due date, we impose finance charges beginning on the date transactions were posted to the account.

Terms and conditions may vary for other products, such as the Discover Business Card, Discover Motiva Card and our U.K. cards.

CEO BACKGROUND

David W. Nelms has served as our Chief Executive Officer since 2004, and was President and Chief Operating Officer from 1998 to 2004. Mr. Nelms was also our Chairman from 2004 until our spin-off. Prior to joining Discover, Mr. Nelms worked at MBNA America Bank from 1990 to 1998, most recently as a Vice Chairman. Mr. Nelms holds a Bachelor’s of Science degree in Mechanical Engineering from the University of Florida and an M.B.A. from Harvard Business School.

Roger C. Hochschild has served as President and Chief Operating Officer since 2004, and was Executive Vice President, Chief Marketing Officer from 1998 to 2001. From 2001 to 2004, Mr. Hochschild was Executive Vice President, Chief Administrative and Chief Strategic Officer of our former parent Morgan Stanley. Mr. Hochschild holds a Bachelor’s degree in Economics from Georgetown University and an M.B.A. from the Amos Tuck School at Dartmouth College.

Roy A. Guthrie has served as Executive Vice President, Chief Financial Officer since 2005. Prior to joining Discover, Mr. Guthrie was President, Chief Executive Officer of CitiFinancial International, LTD, a Consumer Finance Business of Citigroup, from 2000 to 2004. In addition Mr. Guthrie served on Citigroup’s Management Committee during this period of time. Mr. Guthrie served as Chief Financial Officer of Associates First Capital Corporation from 1996 to 2000, while it was a public company and served as a member of its board from 1998 to 2000. Mr. Guthrie holds a Bachelor’s degree in Economics from Hanover College and an M.B.A. from Drake University.

Kathryn McNamara Corley has served as Executive Vice President, General Counsel and Secretary since February 2008. Prior thereto, she had served as Senior Vice President, General Counsel and Secretary since 1999. Prior to becoming General Counsel, Ms. Corley was Managing Director for our former parent Morgan Stanley’s global government and regulatory relations. Ms. Corley holds a Bachelor’s degree in Political Science from the University of Southern California and a J.D. from George Mason University School of Law.

Mary Margaret Hastings Georgiadis has served as Executive Vice President, Chief Marketing Officer since 2004. Ms. Georgiadis was at McKinsey & Company from 1986 to 1988 and 1990 to 2004, most recently as Partner. At McKinsey & Company, Ms. Georgiadis headed the marketing and retail practices and also cofounded and led the customer acquisition and management and retail practices. Ms. Georgiadis holds a Bachelor’s degree in Economics from Harvard-Radcliffe Colleges and an M.B.A. from Harvard Business School.

Charlotte M. Hogg has served as Senior Vice President and Managing Director of our international business since 2004. Ms. Hogg was a Managing Director and Head of our former parent Morgan Stanley’s Strategic Planning Group from 2001 to 2004. Ms. Hogg holds a Bachelor’s degree in Economics and History from Oxford University and was a Kennedy Memorial Trust Scholar at the John F. Kennedy School of Government at Harvard University.

Carlos Minetti has served as Executive Vice President, Cardmember Services and Consumer Banking since September 2006. Prior thereto, he had been Executive Vice President, Cardmember Services since January 2001 and Executive Vice President, Cardmember Services and Risk Management since January 2003. Prior to joining Discover, Mr. Minetti worked in card operations and risk management for American Express from 1987 to 2000, most recently as Senior Vice President. Mr. Minetti holds a Bachelor’s of Science degree in Industrial Engineering from Texas A & M University and an M.B.A. from the University of Chicago.

Diane E. Offereins has served as Executive Vice President, Chief Technology Officer since 1998. In addition, she was appointed to oversee the PULSE Network in 2006. From 1993 to 1998, Ms. Offereins was at MBNA America Bank, most recently as Senior Executive Vice President. Ms. Offereins holds a Bachelor of Business Administration degree in Accounting from Loyola University.

James V. Panzarino has served as Senior Vice President, Chief Credit Risk Officer since 2006, and was Senior Vice President, Cardmember Assistance from 2003 to 2006. Prior to joining Discover, Mr. Panzarino was Vice President of External Collections and Recovery at American Express from 1998 to 2002. Mr. Panzarino holds a Bachelor’s degree in Business Management and Communication from Adelphi University.

Harit Talwar has served as Executive Vice President, Discover Network since December 2003. From 2000 to 2003, Mr. Talwar was Managing Director for Discover’s international business. Mr. Talwar held a number of positions at Citigroup from 1985 to 2000, most recently Country Head, Consumer Banking Division, Poland. Mr. Talwar holds a B.A. Hons degree in Economics from Delhi University in India and received his M.B.A. from the Indian Institute of Management, Ahmedabad.

MANAGEMENT DISCUSSION FROM LATEST 10K

Introduction and Overview

We are a leading credit card issuer and electronic payment services company with one of the most recognized brands in U.S. financial services. We offer credit and prepaid cards and other financial products and services to qualified customers in the United States and the United Kingdom, and provide payment processing and related services to merchants and financial institutions in the United States. Our year ends on November 30 of each year.

We strive to increase net income and achieve other business objectives by growing loan receivables and increasing volume on our payments networks to generate interest and fee revenue, while controlling loan losses and expenses. Our primary revenues come from interest income earned on loan receivables, securitization income derived from the transfer of credit card loan receivables and subsequent issuance of beneficial interests through securitization transactions, and fees earned from cardmembers, merchants and issuers. Our primary expenses include funding costs (interest expense), loan losses, cardmember rewards and expenses incurred to grow and service our loan receivables (e.g., compensation expense and marketing).

We are actively pursuing a strategy to increase acceptance of Discover Network cards among small and mid-size merchants. We have entered into arrangements with major merchant acquirers to sign new and service existing small and mid-size merchants for acceptance of Discover Network cards.

We undertook a number of initiatives in an effort to restore profitability to our U.K. operations over the long term and offset the impact of higher loan losses and lower interchange and fee revenues. These initiatives included insourcing of our processing platform, consolidation of our operational centers, reductions in staffing and achieving procurement efficiencies. In addition, we revised certain risk policies, modified pricing for portions of the portfolio, implemented annual fees for certain customers, introduced new fee products and modified certain transaction based fees. On February 7, 2008, we announced that we had entered into a definitive sale and purchase agreement to sell our U.K. credit card business, which represents substantially all of the International Card segment, to Barclay’s Bank Plc. See “—Sale of International Card Segment; First Quarter 2008 Charge” below for further discussion.

Our business activities have been funded primarily through the process of asset securitization, the raising of consumer deposits, and, prior to the Distribution, intercompany lending from Morgan Stanley which has been replaced with asset-backed financing and both secured and unsecured debt. In a credit card securitization, loan receivables are first transferred to securitization trusts, from which beneficial interests are issued to investors. We continue to own and service the accounts that generate the securitized loans. The trusts utilized by us to facilitate asset securitization transactions are not our subsidiaries and are independent from us. These trusts are excluded from our consolidated and combined financial statements in accordance with GAAP. Because our securitization activities qualify as sales under GAAP and accordingly are not treated as secured financing transactions, we remove credit card loan receivables equal to the amount of the investor interests in securitized loans from the consolidated and combined statements of financial condition. As a result, asset securitizations have a significant effect on our consolidated and combined financial statements in that the portions of interest income, provision for loan losses and certain components of other income related to the securitized loans against which beneficial interests have been issued are no longer recorded in our consolidated and combined statements of income; however, they remain significant factors in determining the securitization income we receive on our retained beneficial interests in those transactions. Securitization income is our second most significant revenue category.

Our senior management evaluates business performance and allocates resources using financial data that is presented on a managed basis. Managed loans consist of our on-balance sheet loan portfolio, loans held for sale and loan receivables that have been securitized and against which beneficial interests have been issued. Owned loans, a subset of managed loans, refer to our on-balance sheet loan portfolio and loans held for sale and include the undivided seller’s interest we retain in our securitizations. A managed basis presentation, which is a non-GAAP presentation, involves reporting securitized loans with our owned loans in the managed basis statements of financial condition and reporting the earnings on securitized loans in the same manner as the owned loans instead of as securitization income. The managed basis presentation generally reverses the effects of securitization transactions; however, there are certain assets that arise from securitization transactions that are not reversed. Specifically, these assets are the cash collateral accounts that provide credit enhancement to the investors in the transactions and cardmember payments allocated to the securitized loans, both of which are held at the trusts. These assets also include the interest-only strip receivable, reflecting the estimated fair value of the excess cash flows allocated to securitized loans and retained certificated beneficial interests. Income derived from these assets representing interest earned on accounts at the trusts, changes in the fair value of the interest-only strip receivable and interest income on investment securities also are not reversed in a managed presentation.

Management believes it is useful for investors to consider the credit performance of the entire managed loan portfolio to understand the quality of loan originations and the related credit risks inherent in the owned portfolio and retained interests in our securitizations. Managed loan data is also relevant because we service the securitized and owned loans, and the related accounts, in the same manner without regard to ownership of the loans.

Financial measures using managed data are non-GAAP financial measures. Whenever managed data is presented in this annual report on Form 10-K, a reconciliation of the managed data to the most directly comparable GAAP-basis financial measure is provided. See “—GAAP to Managed Data Reconciliations.”

Key Developments Impacting Reported Results


•

In August 2007, management began a strategic review of the International Card segment. This review, which was completed in the fourth quarter, involved a review of U.K. financing options and costs (particularly given market disruptions), consideration of industry trends in the United Kingdom, the various challenges facing credit card issuers in that market, the impact of certain initiatives we have already undertaken to restore profitability to the segment and the expected impact of additional actions planned in light of these circumstances. As a result of the strategic review, management revised its long-range projections for the International Card segment, and revised its estimate of the segment’s fair value. The carrying value of the International Card segment at November 30, 2007 was in excess of its revised estimated fair value, and, as such, we recorded a non-cash impairment charge of $391 million ($279 million after tax) to other expense. The total pretax impairment charge included a $291 million write-down of goodwill and $100 million write-down of other intangible assets.


•

Certain of our interest-earning assets and interest-bearing liabilities have floating rates which are tied to short-term market indices, such as the Federal Funds rate and LIBOR. During the year ended November 30, 2006, the Federal Reserve increased the Federal Funds target rate by 125 bps to 5.25%. As a result, the yields on interest-earning assets and the costs of floating rate interest-bearing liabilities increased during 2006 and remained at these levels for most of 2007. During this period, the relationship between the Federal Funds rate and LIBOR remained stable.

During the fourth quarter of 2007, in response to worsening credit conditions, the Federal Reserve decreased the Federal Funds target rate by 75 basis points to 4.50%. During this period, tight credit conditions caused the relationship between the Federal Funds rate and LIBOR to change materially, with LIBOR often remaining significantly higher than the Federal Funds rate. Also, asset-backed commercial paper rates rose and credit spreads widened materially.


Market conditions also reduced the availability of new issuance in certain funding markets. In response to various liquidity events, our senior management increased the size of our liquidity reserve.


•

In the United Kingdom, disruptions in the financial markets as well as a weakened consumer credit environment have impacted asset-backed securitization issuance, leading us to retain on our balance sheet approximately $500 million of receivables from a maturing asset-backed transaction as of November 30, 2007.


•

On June 30, 2007, our Distribution from Morgan Stanley became effective. Our results of operations for the year ended November 30, 2007 include costs incurred as a result of the Distribution of approximately $34 million.


•

New U.S. bankruptcy legislation became effective in October 2005, making it more difficult for consumers to declare bankruptcy. We experienced a surge in bankruptcy receipts leading up to the effective date of this legislation. We charge off bankrupt accounts at the end of the month that is 60 days following the receipt of notification of the bankruptcy, so in the second half of calendar 2005 we experienced higher charge-offs as a result of this legislation. October 2005 was the peak month for bankruptcy receipts during this transition to new legislation. October receipts, in accordance with our policy, were charged off in December 2005.


The results of 2005 were adversely impacted by a higher level of bankruptcy charge-offs, a negative revaluation of the interest-only strip receivable reflecting the impact on projected excess spread of elevated charge-offs in December 2005 and additional provisions to the allowance for loans losses for bankrupt accounts in the portfolio at November 30, 2005. We experienced a dramatic decline in bankruptcy receipts following the effective date of the new U.S. bankruptcy legislation. The results of 2006 benefited from a significantly lower level of bankruptcy charge-offs, a favorable revaluation of the interest-only strip receivable reflecting higher excess spread projections and a decrease in the level of allowance for loan losses. We believe the passing of this legislation negatively impacted 2005 and benefited the overall results of 2006, causing year-over-year comparisons to the year ended November 30, 2007 to be impacted as well. During 2007, the Company experienced a higher level of bankruptcy charge-offs, although still significantly lower than pre-legislation levels.


•

Separate from the previously described impact of the surge in bankruptcy receipts, the underlying credit quality of the U.S. loan receivables continued to improve in 2006 and 2005 and remained relatively stable throughout most of 2007. In the fourth quarter of 2007, delinquencies began to rise reflecting the downturn in market conditions.


•

During 2006 and 2005, certain matters caused our use of certain funding sources, including the U.S. credit card securitization market, to vary from our historical use of this market for funding our business. Following Morgan Stanley’s announcement in April 2005 to explore a spin-off of Discover, the counter party credit ratings on Discover Bank were lowered to their current levels. As a result of our lower credit ratings, we lost access to Federal Funds as a significant source of short-term financing, but were able to mitigate the impact by increasing short-term borrowings from Morgan Stanley.




In response to the exploration of the spin-off, Moody’s placed the asset-backed securities issued domestically by the Discover Card Master Trust I (“DCMT”) under review for a possible downgrade, which we believe contributed to a temporary disruption in our ability to access the securitization markets. This disruption lasted approximately five months, at which time Moody’s re-affirmed the ratings on the asset-backed securities. This deferral of new securitization transactions, as well as a high level of maturities of existing securitization transactions and the discontinued issuance of new short-term certificates from the DCMT in response to higher projected charge-offs following the October 2005 effective date of the new U.S. bankruptcy legislation, caused the level of securitized loans in 2005 to decrease below prior year levels. These effects lingered into 2006, causing outstanding securitization transactions to remain somewhat lower than historical levels on average. In August 2005, Morgan Stanley announced that it would not pursue a spin-off of Discover.


•

During the last three years, there have been increasing regulatory initiatives in the United Kingdom with respect to late and overlimit fees, interchange fees and the sale of retail insurance products, and a relaxation of bankruptcy laws that have made it more difficult to collect on delinquent accounts and easier for cardmembers to declare bankruptcy. The changes contributed to increased U.K. bankruptcy charge-offs and lower late fee, overlimit fee and interchange revenues.


•

In February 2006, we acquired the Goldfish credit card business in the United Kingdom, adding approximately $1.4 billion in receivables. Under the terms of the acquisition, we did not purchase any late stage delinquencies. As such, the year ended November 30, 2006 reflects a lower level of charge-offs than the year ended November 30, 2007, which includes the full impact of the Goldfish acquisition.

Sale of International Card Segment; First Quarter 2008 Charge



On February 7, 2008 the Company and Barclays Bank Plc entered into a definitive sale and purchase agreement relating to the sale of £129 million of net assets (equivalent to approximately $258 million) of the Company’s U.K. credit card business, which represented substantially all of the Company’s International Card segment and included $3.1 billion in owned loan receivables at November 30, 2007. The aggregate sale price under the agreement is £35 million (equivalent to approximately $70 million), payable in cash at closing and subject to a post-closing adjustment. The closing is expected to occur by the end of the Company’s second quarter of 2008. As a result, the International Card segment will be presented as discontinued operations beginning with first quarter 2008 reporting. The sale is subject to the satisfaction of a number of conditions, including clearance from the U.K. Office of Fair Trading, a minimum value of receivables to be transferred and consents under material contracts. There can be no assurance that the sale will occur by the end of the second quarter of 2008, if at all.

Based on the terms of the sale, the Company expects to record charges of approximately $240 to $270 million pre-tax ($190 to $210 million after tax) in the first quarter of 2008 associated with classifying the segment as held for sale, substantially all of which will be non-cash. These charges, the majority of which are expected to be recognized in the first quarter of 2008, include approximately $5 million related to the termination of certain contractual arrangements and approximately $7 million of employee-related costs. This will be partially offset by the proceeds from the sale of other assets related to the U.K. business of approximately $45 million.

Segments

We manage our business activities in three segments: U.S. Card, Third-Party Payments and International Card. In compiling the segment results that follow, the U.S. Card segment bears all overhead costs that are not specifically associated with a particular segment and all costs associated with Discover Network marketing, servicing and infrastructure, with the exception of an allocation of direct and incremental costs driven by the Third-Party Payments segment.

U.S. Card. The U.S. Card segment offers Discover Card-branded credit cards issued to individuals and small businesses over the Discover Network. Also included within the U.S. Card segment are our other consumer products and services businesses, including prepaid and other consumer lending and deposit products offered through our subsidiary, Discover Bank.

Third-Party Payments. The Third-Party Payments segment includes PULSE and our third-party payments business.

International Card. The International Card segment offers consumer finance products and services in the United Kingdom, including Morgan Stanley-branded, Goldfish-branded and various affinity-branded credit cards issued on the MasterCard and Visa networks.

U.S. Card

The U.S. Card segment reported pretax income of $1.5 billion for the year ended November 30, 2007, down 8% as compared to November 30, 2006. The decrease in pretax income was driven by an increase in provision for loan losses partially offset by higher net interest income. Provision for loan losses increased $189.9 million, or 11%, reflecting an increase in bankruptcy charge-offs compared to the unusually low levels in 2006 and a higher level of loans retained on our balance sheet. Net interest income increased $59.1 million, or 2%, due to higher interest income, reflecting higher average receivables, partially offset by an increase in interest expense, reflecting increased funding costs and borrowings.

For the year ended November 30, 2007, managed loans grew 5%, to $48.2 billion, driven by record sales volume of $90.3 billion, up 4% over last year. U.S. credit quality remained strong, although delinquency rates increased from last year reflecting weakening in the U.S. economy. The managed net charge-off rate of 3.84% was down 12 basis points from last year and the over 30 day delinquency rate of 3.59% was 20 basis points higher than last year. In 2008 we estimate the full year managed net charge-off rate will be between 4.75% and 5.00%.

A small portion of our newly-originated loans are issued to borrowers with FICO scores below 660 at the time of account origination but who have met our other specific underwriting criteria indicating to us that they have the ability and willingness to pay. We have restricted this initiative to potential customers with FICO scores above 600, and the majority of these new accounts had FICO scores at origination in the 640 to 660 range. At November 30, 2007, less than 3.5% of receivables related to new accounts originated within the year were at FICO scores below 660 at time of origination.

While we seek to carefully control the level of new account originations at FICO scores below 660, over time some accounts that were originated at higher FICO scores will migrate to levels below 660 due to circumstances that affect their credit performance. Consistent with industry standards for reporting securitization U.S. master trust data, we disclosed that as of October 31, 2007, approximately 26% of receivable balances in the domestic trust related to accounts with FICO scores below 660 at that date. While this percentage relates solely to credit card receivables held in the trust, we believe they are representative of our managed loan portfolio.

The U.S. Card segment produced strong results for the year ended November 30, 2006, with pretax income of $1.6 billion, up 72%, as compared to November 30, 2005. These results reflected the strong credit quality of the domestic managed credit card portfolio and the continued favorable impact of the new U.S. bankruptcy legislation on charge-offs, the revaluation of the interest-only strip receivable and the allowance for loan losses. The increase in pretax income was due to higher other income and a lower provision for loan losses partially offset by lower net interest income and higher other expenses. Other income increased $343.8 million, or 20%, due primarily to an increase in the fair value of our interest-only strip receivable as a result of lower bankruptcy receipts and our estimate of its related favorable impact on future charge-offs as well as a higher level of new securitization transactions. Provision for loan losses decreased $600.1 million, or 27%, reflecting strong credit quality and lower bankruptcy charge-offs. Net interest income decreased $149.9 million, or 4%, as higher interest expense was partially offset by higher interest income. The increase in interest expense was primarily due to an increase in the cost of funds driven by the rising interest rate environment. The increase in interest income reflects lower interest charge-offs due to improved credit quality and the effect of a rising interest rate environment on floating rate credit card loan receivables partially offset by higher promotional rate balances. Other expense increased $109.8 million, or 5%, driven by higher compensation and benefits expense and increased legal fees, primarily related to the litigation against Visa and MasterCard, and consulting costs, partially offset by lower cardmember fraud expense.

For the year ended November 30, 2006, managed credit card loans grew 3%, to $45.7 billion, driven by higher transaction volume partially offset by higher cardmember payment rates. Sales volume increased 6%, primarily reflecting increased cardmember usage and higher prices of gasoline (which represents approximately 8% of sales volume). Managed interest spread compressed 50 basis points as increased cost of funds outpaced higher interest yield. The managed net charge-off rate of 3.96% decreased 134 basis points, reflecting strong credit quality and lower bankruptcy charge-offs. Over 30 and over 90 day delinquency rates decreased 59 basis points and 16 basis points to 3.39% and 1.59%, respectively, due to a shift to loans with lower risk profiles and improved collection experience.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Qualifying Special Purpose Entities

The Financial Accounting Standards Board (“FASB”) has projects underway to amend and clarify Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, as amended (“Statement No. 140”) and FASB Interpretation No. 46R, Consolidation of Variable Interest Entities (“FIN 46R”). As part of these projects, in April 2008, FASB members proposed the elimination of the concept of a qualifying special purpose entity (“QSPE”) which is defined in Statement No. 140. QSPEs are currently exempt from the consolidation provisions of FIN 46R and as a result, amendments to that standard are being considered as well. Revised guidance has not been finalized for either standard. The FASB will issue its proposed amendments for public comment and, based upon public comments received and other considerations, may revise the amendments before issuing final guidance. The proposed changes may make it more difficult for us to maintain or establish sale accounting treatment in connection with transfers of financial assets in securitization transactions and could result in consolidation of the securitization entities by us. This would have a significant impact on our consolidated financial statements. For example, the impact of the potential consolidation, if applied as of May 31, 2008, may require us to add approximately $26 billion of securitized receivables to our assets, add the related debt issued to third-party investors to our

liabilities, and reclassify amounts due from securitization. The effective dates of amended standards have not yet been determined but could be as early as December 2008. For more information, see “Future guidance from the Financial Accounting Standards Board may impact the accounting treatment of the securitization of our credit card receivables, which could materially adversely affect our financial condition, reserve requirements, capital requirements, liquidity, cost of funds and operations” under “Part II. Other Information—Item 1A. Risk Factors” in this quarterly report.

Federal Reserve Board Proposed Amendments

The Federal Reserve Board has proposed amendments to regulations that would place limitations on certain credit card practices, including, but not limited to, restrictions on applying rate increases to existing balances, payment allocation and default pricing. The Federal Reserve Board has indicated it hopes to publish final rules by the end of the year. For more information, see “ The Federal Reserve Board’s proposed amendments to regulations, if adopted as proposed, would have a material adverse effect on our results of operations ” under “Part II. Other Information—Item 1A. Risk Factors” in this quarterly report.

The remaining discussion provides a summary of the results of operations for the three and six months ended May 31, 2008 and 2007, as well as the financial condition at May 31, 2008 and November 30, 2007. All information and comparisons are based on continuing operations.

Segments

We manage our business activities in two segments: U.S. Card and Third-Party Payments. In compiling the segment results that follow, the U.S. Card segment bears all overhead costs that are not specifically associated with a particular segment and all costs associated with Discover Network marketing, servicing and infrastructure, with the exception of an allocation of direct and incremental costs driven by the Third-Party Payments segment.

U.S. Card. The U.S. Card segment includes Discover Card-branded credit cards issued to individuals and small businesses over Discover’s signature card network and other consumer products and services business, including prepaid and other consumer lending and deposit products offered through our Discover Bank subsidiary.

Third-Party Payments . The Third-Party Payments segment includes PULSE Network (“PULSE”), an automated teller machine, debit and electronic funds transfer network, and our third-party payments business.

The segment discussions that follow for the three and six months ended May 31, 2008 and 2007 are on a managed basis.

U.S. Card

The U.S. Card segment reported pretax income of $309.1 million for the three months ended May 31, 2008, down 20%, as compared to May 31, 2007. The decrease in pretax income was driven by higher provision for loan losses and lower other income, which was partially offset by an increase in net interest income. Provision for loan losses increased $137.3 million, or 31%, as a result of higher net charge-offs, which reflects current economic conditions and recent delinquency trends. Other income decreased $71.2 million, or 14%, due to a $44.5 million unfavorable net revaluation of our retained interest in securitizations as compared to a $36.4 million favorable net revaluation in the second quarter of 2007, and a $31.3 million write-down of our investment in asset-backed commercial paper notes in Golden Key U.S. LLC, partially offset by higher discount and interchange revenue due to growth in sales volume and lower rewards costs related to revised forfeiture assumptions. Net interest income increased $114.0 million, or 13%, reflecting widening net interest margins benefiting from lower cost of funds and a reduction in, and higher rates on, promotional balances.

The U.S. Card segment reported pretax income of $684.5 million for the six months ended May 31, 2008, down 13%, as compared to May 31, 2007. The decrease in pretax income was driven by higher provision for loan losses, which was partially offset by increased net interest income. Provision for loan losses increased $358.3 million, or 42%, as a result of higher charge-offs and a higher allowance for loan losses. The allowance for loan losses increased due to loan growth and an increase in the loan loss reserve rate, which is reflective of the current credit environment and recent delinquency trends. Net interest income increased $208.7 million, or 12%, as interest income benefited from higher average loan receivables as well as an increase in the level of interest-earning assets related to the liquidity reserve, partially offset by an increase in borrowings to support the asset growth.

For the three months ended May 31, 2008, managed loans grew 2%, to $47.8 billion. This increase in loans is attributable to an increase in installment loans and an increase in sales volume of $22.5 billion, up 2% over last year. The weakening economic environment adversely impacted cardmember delinquencies and charge-offs. The managed over 30 day delinquency rate for the segment, including non-credit card loans, was 3.81%, 84 basis points higher than last year, and the managed credit card over 30 day delinquency rate was 3.85%, up 88 basis points from last year. For the three months ended May 31, 2008, the managed segment and credit card charge-off rates were 4.99% and 5.05%, up 102 and 108 basis points from the three months ended May 31, 2007, respectively. For the six months ended May 31, 2008, the managed segment and credit card charge-off rates were 4.66% and 4.70%, up 75 and 78 basis points from the comparable prior year period, respectively.

Third-Party Payments

The Third-Party Payments segment reported pretax income of $16.8 million for the three months ended May 31, 2008, more than double the pretax income of $8.0 million reported for the three months ended May 31, 2007. The increase in pretax income was driven by increased revenues from transaction growth and an increase in fee revenue along with a decline in transaction processing and consulting costs. Third-Party Payment debit and credit volume was $29.4 billion, up 33% compared to last year, reflecting the impact of new issuer signings in 2007 as well as increased volumes from existing issuers.

The Third-Party Payments segment reported pretax income of $32.3 million for the six months ended May 31, 2008, up 62%, as compared to May 31, 2007. The increase in pretax income was driven by increased revenues from transaction growth, $3 million in revenue related to one-time contractual payment, a decline in transaction processing and consulting costs and an increase in fee revenue, partially offset by marketing and pricing incentives. Third-Party Payments debit and credit volume was $55.8 billion, up 29% compared to last year, reflecting the impact of new issuer signings in 2007 as well as increased volumes from existing issuers.

GAAP to Managed Data Reconciliations

Securitized loans against which beneficial interests have been issued to third parties are removed from our statements of financial condition. Instances in which we retain certificated beneficial interests in the securitization transactions result in a reduction to loan receivables of the amount of the retained interest and a corresponding increase in investment securities—available-for- sale. The portions of interest income, provision for loan losses and certain components of other income related to the securitized loans against which beneficial interests have been issued are no longer recorded in our statements of income; however, they remain significant factors in determining the securitization income we receive on our retained beneficial interests in those transactions. Management believes it is useful for investors to consider the credit performance of the entire managed loan portfolio to understand the quality of loan originations and the related credit risks inherent in the owned portfolio and retained interests in securitization. Loan receivables on a GAAP (or owned) basis and related performance measures, including yield, charge-offs and delinquencies can vary from those presented on a managed basis. Generally, loan receivables included in the securitization trusts are derived from accounts that are more seasoned, while owned loan receivables represent a greater concentration of newer accounts, occurring as a result of the degree to which receivables from newer accounts are added to the trusts. The seasoning of an account is measured by the age of the account relationship. In comparison to more seasoned accounts, loan receivables of newer accounts typically carry lower interest yields resulting from introductory offers to new cardmembers and lower charge-offs and delinquencies.

Beginning with “—Earnings Summary,” the discussion of GAAP results is presented on a consolidated and combined basis with any material differences between segment performance specifically identified. The table that follows provides a GAAP to managed data reconciliation of loan receivables and related statistics that are impacted by asset securitization:

Critical Accounting Policies

In preparing the consolidated and combined financial statements in conformity with GAAP, management must make judgments and use estimates and assumptions about the effects of matters that are uncertain. For estimates that involve a high degree of judgment and subjectivity, it is possible that different estimates could reasonably be derived for the same period. For estimates that are particularly sensitive to changes in economic or market conditions, significant changes to the estimated amount from period to period are also possible. Management believes the current assumptions and other considerations used to estimate amounts reflected in the consolidated and combined financial statements are appropriate. However, if actual experience differs from the assumptions and other considerations used in estimating amounts in the consolidated and combined financial statements, the resulting changes could have a material adverse effect on the consolidated results of operations and, in certain cases, could have a material adverse effect on the consolidated financial condition. Management has identified the policies related to the estimation of the allowance for loan losses, the accounting for asset securitization transactions, interest income recognition, the accrual of cardmember rewards cost, the evaluation of goodwill for potential impairment and accrual of income taxes as critical accounting policies.

These critical accounting policies are discussed in greater detail in our annual report on Form 10-K for the year ended November 30, 2007. That discussion can be found within Management’s Discussion and Analysis of Financial Condition and Results of Operations under the heading Critical Accounting Policies. There have not been any material changes in the critical accounting policies from those discussed in our 10-K for the year ended November 30, 2007.

Income from continuing operations for the three months ended May 31, 2008 was $201.6 million, down 19% compared to the three months ended May 31, 2007, driven by lower net interest income and higher provision for loan losses. Net interest income decreased $35.4 million due to a decrease in interest income and an increase in interest expense. The provision for loan losses increased reflecting higher net charge-offs as a result of the weakening economic environment.

Income from continuing operations for the six months ended May 31, 2008 was $440.4 million, down 14% compared to the six months ended May 31, 2007, driven by lower net interest income and higher provision for loan losses, partially offset by higher other income. Net interest income decreased $72.5 million due to an increase in interest expense, partially offset by an increase in interest income. The provision for loan losses increased reflecting higher net charge-offs and a higher allowance for loan losses as a result of the weakening economic environment. Other income increased primarily due to higher securitization income which resulted from higher excess spread on securitized loans.

Net Interest Income

Net interest income represents the difference between interest income earned on interest-earning assets which we own and the interest expense incurred to finance those assets. Net interest margin states the interest income, net of interest expense, as a percentage of total interest-earning assets. Our interest-earning assets consist primarily of loan receivables, certain retained interests in securitization transactions included in amounts due from asset securitization and investment securities, and our liquidity reserve which includes Federal Funds sold and bank deposits. Investor interests in securitization transactions that have been transferred to third parties are not assets which we own, and accordingly, have been excluded from interest-earning assets. Similarly, interest income does not include the interest yield on the related loans.

Interest income is influenced by the amount of interest-earning assets we own, the most significant of which is our loan receivables. Our loan receivables can be influenced by portfolio growth strategies, cardmember spending and payment behavior, and changes in the amount of our securitized loans. Typically, new securitization transactions have the effect of decreasing loan receivables, whereas maturities of existing securitization transactions increase loan receivables. Interest income is also influenced by changes in certain amounts due from asset securitization, which are the largest component of other interest-earning assets. The levels of these assets are impacted by securitization maturities and can vary in relation to the level of securitized loans. Additionally, the liquidity reserve, which may vary based on market conditions and liquidity targets, has an impact on interest income.

Changes in the interest rate environment can influence the interest yield earned on interest rate sensitive assets, and accordingly impact interest income. Credit card loan receivables earn interest at both fixed rates as well as floating rates tied to the prime rate, the mix of which can vary over time. During the three months and six months ended May 31, 2008, average credit card loan receivables earning interest at floating rates decreased to 40% and 42%, respectively, of average loan receivables as compared to 56% and 58% during the three and six months ended May 31, 2007, respectively. The decreases in the percentage of floating rate credit card loan receivables helped to minimize the adverse impact on interest yield of the declining interest rate environment. Other interest rate sensitive assets, specifically our liquidity reserve and certain retained interests in securitization transactions, also were adversely impacted by the declining interest rate environment.

Credit performance is another factor which influences interest yield of loan receivables. Charge-offs related to finance charge balances are recorded as a reduction to interest income. Accordingly, an increase in the level of finance charge charge-offs can adversely impact interest yield and interest income.

Interest-bearing liabilities reflect our funding requirements and consist primarily of deposits and, to a lesser degree, borrowings. We incur interest expense on our interest-bearing liabilities at fixed rates as well as floating rates which are tied to various short-term market indices. Accordingly, changes in the interest rate environment, changes in the percentage of floating rate interest-bearing liabilities and the replacement of maturing debt can impact interest expense. Interest expense also includes the effects of certain interest rate swaps we enter into as part of our interest rate risk management program. During the three and six months ended May 31, 2008, floating rate average interest-bearing liabilities as a percentage of total average interest-bearing liabilities were 34% and 36%, respectively, as compared to 45% and 52% for the respective prior year comparisons. The decreasing interest rate environment favorably impacted our funding costs during the three month and six months ended May 31, 2008.

CONF CALL

Craig Streem

I want to begin by reminding everyone that the discussion today contains certain forward-looking statements about the company’s future financial performance and business prospects which are subject to risks and uncertainties and speak only as of today. Factors that could cause actual results to differ materially from these forward-looking statements are set forth within today’s earnings press release which was furnished to the SEC in an AK report and in the company’s Form 10-K for the year ended November 30, 2007 which is on file with the SEC.

In the third quarter 2008 earnings release and supplement, which are now posted on our web site at discoverfinancial.com and have been furnished to the SEC, we have provided information that compares and reconciles the company’s managed basis financial measures with the GAAP financial information and we explain why these presentations are useful to management and to investors and we would urge you to review that information in conjunction with today’s discussion.

Our call this morning will include formal remarks from David Nelms, our chief executive officer and Roy Guthrie, our chief financial officer and of course we will have plenty of time for a question and answer session.

Now it is my pleasure to turn the call over to David.

David Nelms

I am going to begin with an overview of our third quarter results and then cover a number of topics including credit, receivables growth, our merchant acceptance strategy, and also the performance of our payments business. Roy is going to then give you more details on our results and then we’ll both take your questions.

Very simply this historically tough environment for many financial services companies and consumers, given that environment, our business model has enabled us to turn in another solid quarter with net income from continuing operations at $179 million or $0.37 per share. We achieved this strong performance in the key areas of growth, margin, and expense management offset by higher loss provisions reflecting the current environment.

Touching on some of the highlights, receivables growth came in at 6% and revenue net of interest expense was $1 billion 6, up 14%. Our continued focus on expense control bore fruit again this quarter with non-interest expenses down 2%.

Our payment segment achieved pre-tax income of $29 million, significantly above last years level, in part reflecting the contribution from two months of Diners Club results. Offsetting these very positive factors was the significant increase in our credit loss provision, up over $300 million from last year, which reflects the weak consumer credit environment and growth in our on balance sheet loans.

Turning to the specifics, let me begin with more detail about our credit performance. First and foremost our quarterly credit performance continues to track with our expectations with charge-offs for the quarter at 5.2% and we remain comfortable with our fourth quarter guidance for charge-offs in the mid 5% range.

Our 30-day plus delinquency rate was 3.85%, virtually flat sequentially, while charge-off rates continued to rise. This is different than the traditional pattern because a greater percentage of delinquent accounts are now flowing through the delinquency buckets and into charge-off and also because of an increase in consumer bankruptcy filings. We believe these trends reflect a contraction in the availability to consumers of alternative forms of credit as well as stress in many consumers household cash flow.

We are pleased that our credit performance continues to be among the best in our industry, reflecting our disciplined growth and highly seasoned portfolio, our favorable geographic distribution, and our use of sophisticated analytical tools in our underwriting and line management processes. We also feel we have an advantage due to our in-house collections staff who serves us and our card members’ very well, particularly I this time of stress.

Turning to sales and receivables growth, results came in a bit stronger this quarter as card members took greater advantage of Discover products and programs. As an example, nearly $4 million customers signed up to earn a 5% cash back bonus on gas purchases this summer using our Discover More card. Offered right in the middle of the midst of the spike in oil prices, this card helped our cardholders get some relief from the pressure at the pump.

Balance transfer volume was up this quarter about 11% year-over-year. We continue to be very selective with our balance transfer efforts with somewhat shorter durations and we also continue to offer existing customers closed end personal loans geared to debt consolidation.

I am also especially pleased with the strength of our direct to consumer deposit business which we expanded by over $1 billion this quarter. Recently consumer demand for Discover Bank deposit products has increased and given the very attractive characteristics of these products we expect to continue to emphasize this source of cost effective funding and strong customer relations.

In terms of our merchant acceptance strategy, in the third quarter we added an average of over 175,000 new merchants per month. We now have agreements in place with 88 merchant acquirers which represent an estimated 98% of the bankcard sales volume in the US and we continue to rapidly implement with these partners.

The last subject I want to cover is the performance of the third party payment segment, which continues to do extremely well and now includes the results of Diners Club International. Total volume for this segment in the third quarter was $35 billion, up 48%.

We had another great quarter with volume of $28 billion up 27% as we continue to benefit from new issuers and increased volume from existing relationships. Our Discover Network third party issuer business is also growing nicely with volume up $1 billion 7, up 15% from last year. We are seeing good momentum in this business with volume for the last four quarters totaling over $6.3 billion.

Diners Club contributed over $5 billion to our volume this quarter. Now with two months of Diners Club under our belt we are even more excited about our licensee partner relationships and the future benefits of combining our networks and taking advantage of global opportunities.

Before I turn the call over to Roy I want to comment briefly on two matters: the various regulatory and legislative proposals and our litigation with Visa and MasterCard.

We have seen the large amount of credit card related legislative and regulatory activity this quarter and we are providing comments and data on these various proposals. We remain hopeful that the fed will put appropriate regulatory measures in place by year-end.

Regarding our anti-trust litigation seeking damages from Visa and MasterCard, the trial is now set for October 14 and we are ready to make our case with the jury.

Now let me turn the call over to Roy for his comments.

Roy Guthrie

In my comments this morning I am going to amplify just a few of the things you heard David cover and then give you an update on our funding and liquidity of the business.

The U.S. Card segment earned $245 million pre-tax this quarter as we have seen higher loss provisions offset the strong gains in our net interest income, as you heard David say. Also the reduction we saw in non-interest expense year-over-year.

Interest margin was 8.95% and up 116 basis points year-over-year and roughly 70 basis points of that was pure margin expansion while about 45 basis points was attributable to the inclusion in net interest income of the balance transfer fee amortization, which I mentioned to you last quarter.

On a sequential quarter basis the margin adjusted for those fees was essentially flat.

Other income in the card segment was basically flat, but it had an increase due to the lift in sales driving our discount and interchange revenue, but was offset by the loan fee that is now being included up in net interest income. Also in other income there was a $34 million charge for the unfavorable revaluation of our retained interest in securitized assets. Last years quarter included a $24 million charge, so we’re looking at about a $10 million negative swing from this item in that line year-over-year.

Loss provisions were up $336 million from last year reflecting higher charge-offs, but also reflecting reserve additions for our current quarter receivables growth and a further increase in the reserve rate. This quarter we added $113 million to loss reserves in excess of our charge-offs versus a reserve release of $15 million last year, so that represents a $128 million swing in the year-over-year comparison.

As David mentioned we had continued solid growth in the quarter in our non-loan card products, so principally closed end installment loans which are now about $1 billion. This product is an important compliment to the balance transfer activities in the card business as we respond to our customers needs for debt consolidation with a closed end product.

David discussed the volume levels within the components of third party payments, so I’m really not going to expand on that, but I do want to comment briefly on the contribution that Diners has made to the quarter.

As you know we closed the Diners Club acquisition on June 30, so we’ve got two months of the business in our results this quarter. Diners Club contributed about $7 million pre-tax, it’s in the payment segment for the quarter, and this is a lot higher than the guidance that we gave you of that $10 to $15 million per year when we announced the deal and I’m going to talk a little bit about that.

Because we closed the acquisition so recently, we’ve really only just begun to incur the costs that we’re going to need to incur to fully integrate Diners Club with our other networks. Additionally we expect to invest more in marketing to support the licensees around the world, so you should not assume that Diners Club contributions of this segment are going to be at this elevated level ongoing.

Before I go on to discuss funding, I want to comment on the effective tax rate briefly, which was just under 355 this quarter. We had a settlement in one particular state of an outstanding issue that resulted in a one-time tax benefit so this quarter’s tax rate is lower than it otherwise would have been. Going forward I would guide you back to that 38% level that you’ve seen in the quarters preceding this one.

So in terms of funding, the capital markets continue to be under a high degree of stress with credit card asset backed securities marketed continuing to be characterized by fewer players, by wider spreads at issuance and shorter terms.

During the quarter we did a five year fixed rate AAA deal for $750 million and also sold just over $400 million into a partner banks conduit facility. We also established a new $750 million bank conduit facility during the quarter, which brought our total open capacity in partner bank conduits to $1.5 billion.

At this point we’ve got contractual relationships with sponsors of six conduit programs, all very large global financial institutions, all of which have significant experience in the product. We are very comfortable with that line up.

Over the last few months we have seen execution levels in the capital markets pass significantly through the levels at which we can borrow under our deposit programs and therefore you have seen us turn towards our deposit programs to fund the business. As we mentioned in last quarters call we have $2.6 billion in term asset backed security maturities coming up in our next quarter, in the fourth quarter, and that is an unusually high level for us. To put that in perspective I think we’ll do about 10% of our entire ABS book and pretty much equal to the entire 2009 term maturities of $2.9 billion.

So with present market conditions being what they are, we expect that some or all of the fourth quarter maturities of $2.6 billion will be funded by our deposit programs, which has two effects to the income statement: first the assets come back on the balance sheet, so we would have to book reserves against those assets. Second, to the extent the receivables come back on the balance sheet we would have to write down the remaining IO receivable associated with those maturities. As a result, our fourth quarter could have a far greater level of reserve additions and IO write-downs than what we saw here in these third quarter results.

Another note on the fourth quarter is where LIBOR is positioned. Our third quarter master trust LIBOR resets were around 40 to 50 over fed funds at the 2, 240, to 250 sort of level and presently LIBOR is positioned significantly higher; so this could affect our interest expense and IO valuation in the fourth quarter as well if we see those elevated levels remain.

Total deposits reached over $27 billion at the end of the quarter with about $5 billion of that coming from our direct to consumer program.

The direct to consumer deposit funding program is a very important channel for us and we continue to grow it through the direct marketing, which is classical being in the way we’ve been doing it, but as well as through affinity relationships such as our new relationship with AAA.

So in the quarter, direct to consumer deposits grew $1.1 billion and as such this channel is now beginning to make a real contribution to our liquidity and funding. So the growing presence of our direct to consumer capability really compliments the distribution we’ve had for many years through the US wealth management system which represents the other $1.1 billion of deposit growth in the quarter. In this program we work directly with six major financial institutions as well as indirectly with a larger external selling group representing about 200 broker dealers, all of which distribute insure Discover Bank deposit products.

In addition to ramping up the level of deposit issuance in the quarter, we have also been successful in lengthening our certificate of deposit maturities with the average maturity of 27 months at the end of this quarter, up from 22 months last quarter.

Given our strong presence in the deposit markets and the relatively low level of asset-backed maturities we see in 2009, we are well prepared to fund our business through 2009, principally through our deposit platforms.

In terms of liquidity, at quarters end we had $1.5 billion of unused conduit capacity; I mentioned that previously and the $2.5 billion revolving credit facility is still in place and in addition we had $5 billion of AAA capacity in our master trust. We have taken our cash liquidity up $1.2 billion during the quarter to $9.6 billion, in effect pre funding a portion of the fourth quarter ABS maturities I mentioned previously.

We finished the quarter with over $5.5 billion in tangible equity and the ratio of tangible equity to net managed receivables came in at 11.2%, down just a bit from the previous quarter due to growth and the fact that a portion of the Diners Club purchase price was recorded in intangible assets.

So our capital position remains stable and strong and we’ll continue to maintain a cautious posture towards capital given the present environment.

Last week we declared a $0.06 dividend to our shareholders; that’s consistent with the levels that we’ve paid since becoming public. And as I said last quarter, we will not be active in our share repurchase program until we feel better about the overall market environment that we’re operating in.

In response to your questions that we’ve received, I wanted to comment just briefly on our exposure to other financial institutions.

Our $2.5 billion bank revolver is comprised of 25 global financial institutions, with the largest participant being less than 7%, so that’s very, very well spread.

At the end of the third quarter we had a small book of swaps which is expected to continue to shrink as it has over the last year and the net mark-to-market on that position at the end of the third quarter was a $2.5 million receivable, a very small amount there.

Finally, the investment portfolio has no direct exposure to mortgages and is principally invested in prime and government mutual funds and major bank short dated fed funds sold, so a very solid position there as well.

To wrap up, given the stresses of the market, I would echo what I think David said and that is that I think we had a solid quarter.

That concludes our formal remarks; I will turn it back over to you, Keith, for the Q&A.

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