Brought to you by Discover . . . your partner in payment services ISSUE #4 • SPRING 2011

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Welcome to HorizonSM Welcome to the latest issue of HorizonSM —a publication designed exclusively for our credit issuing community partners.

The year 2010 was an interesting time for cards and payments, with legislative, as well as economic, challenges. This issue includes a report on growth in the card industry from First Annapolis, and we’ve asked one of our analytical partners, Mercator Advisors, to share some of their perspectives on the 2011 marketplace. We’ve also included an update from our own Government Relations department that I’m sure you will find interesting.

We are proud to report the latest news in our global expansion areas as partnerships and alliances worldwide have fueled our growth and will continue to do so in the years to come. There are also many new products and services being developed, and we look forward to sharing those with you.

Thank you again for your continued support. As always, we welcome your comments and your feedback.

Best Regards,

Kevin O’Donnell Group Executive, Credit Issuance

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IN THIS ISSUEWashington Viewpoint .......................................... 2International Expansion Broadens Discover® Acceptance ........................................... 3Credit Issuing Outlook for 2011 .............................. 3Unique Promotions and Sponsorships Build Brand Awareness ................................................. 4Did You Know? .................................................. 4Upcoming Industry Events ..................................... 4

Card Industry Growth: A Return to FundamentalsBy John Grund, Partner, First Annapolis

For the first time in years, card issuers are talking about growth, as the triple whammy of the credit crisis, CARD Act and recession gradually give way to the realities of a new competitive environment. One of the starkest challenges facing the industry is where profitable growth will come from as issuers shift their attention from an internal to an external focus and consumers do the same as household balance sheets stabilize. The backdrop for achieving growth is not without problems — unemployment, while improving, remains stubbornly high; the price of gasoline is fast approaching a record; the housing market has not yet recovered; and regulatory uncertainty looms as the new Federal Consumer Financial Protection Bureau takes shape.

In many ways, the card industry is currently in a transitional state. The credit tightening of recent years is paying off as loss rates improve swiftly. Competition for cardholders is intensifying via a new flow of direct mail offers, while certain market segments (e.g., partnerships and even sub-prime) that experienced severe dislocation during the recession are regaining their footing. However, there are mixed messages surrounding the state of the consumer. Holiday season spending in 2010 was a clear indication of pent-up demand at least among the more affluent customer segment, but other customer segments remain cautious and even debt-averse, based on elevated payment rates. Collectively, after a nice bounce of an economic recovery, the challenge of generating profitable growth looms large for the industry. Ironically, the “new normal” sounds a lot like the old normal in that regard.

In our view, long-term industry growth will be driven by a return to fundamentals, some of which were out of synch prior to the credit crisis. Underwriting, arguably the most fundamental aspect of consumer lending, is once again a differentiator and driver of profitable growth with many repricing levers no longer available after the CARD Act. Service, yes service, has the potential to be a growth driver and not just a cost center ripe for automation or off-shoring to the lowest expense location. Consumer trust in many financial institutions was fractured and is in need of repair. Strategic focus is another fundamental that will drive profitable growth — like consumers, issuers spread themselves too thin as they added products, partners and price points during the land grab that was in vogue prior to the crisis.

Despite a rather sobering past two years, the next wave of growth opportunities promises to be quite exciting. Technology alone is paving the way for new forms of electronic payments/ commerce with mobile and tablet devices creating new channels for customer engagement. Consumer behavior is changing in unimaginable ways through various forms of social media capable of influencing choice,

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Card Industry Growth: A Return to Fundamentals (continued from page 1)

The following is an update on congressional activity affecting the consumer credit industry.

Debit Interchange — As the July deadline approaches for compliance with the Dodd-Frank Act debit interchange fee restrictions (“Durbin Amendment”), bipartisan bills introduced in the House and Senate would delay the provision’s effective date pending a study of its impact. Approval of this legislation by the House is likely, but House leaders are expected to delay consideration until the Senate votes. A Senate vote is not expected until the bill’s cosponsors (Senator John Tester (D-MT) and Bob Corker (R-TN)) round up filibuster-proof support of at least 60 senators.

Supporters of the “stop and study” bill are closing in on this goal through cosponsorships and voting commitments, including from senators who supported the Durbin provision in 2010. Senator Tester believes he will prevail, but the outcome remains uncertain.

Meanwhile, the Federal Reserve informed Congress that it will not meet its April deadline for issuing a final interchange regulation, and a U.S. district court considering a challenge to the Durbin Amendment refused to preliminarily enjoin the rule, or dismiss the challenge. Judicial or regulatory action that changed the proposed interchange standards might make some in Congress less willing to support a legislative delay, but so far the pressure for a legislative solution continues.

CFPB — The House Financial Services Committee has been conducting oversight of the creation of the Consumer Financial Protection Bureau, which begins operations in July. Several hearings have been held, and Committee members have sent numerous requests for information to Professor Elizabeth Warren and other members of the Treasury Department’s CFPB “Implementation Team.”

In May, the subcommittee will vote on legislation to restructure the agency. The bill would turn the bureau from an agency

run by a single director into a bipartisan commission, like the FTC and the Consumer Product Safety Commission. The legislation may also require congressional approval of the CFPB’s annual budget (the bureau currently is funded through a guaranteed share of Federal Reserve revenues), and enhance the ability of the inter-agency “Financial Stability Oversight Council” to override CFPB regulations.

This legislation will have strong support in the Republican-controlled House of Representatives. However, its prospects for Senate approval seem dim, and a presidential veto is a strong possibility.

The president has yet to nominate a director for the CFPB, and there is some disagreement about the bureau’s authority after its effective date if a director is not in place. Treasury believes it can exercise all bureau powers while a vacancy exists, but the statute appears to require the approval of a bureau director for rulemaking and other activities.

Business Method Patents — The financial services sector has incurred significant expenses litigating, or settling, claims that patents on methods of doing non-financial business have been infringed upon by financial activities of banks and other financial services providers. Legislation updating U.S. patent laws that has been approved by the U.S. Senate and is under consideration in the House includes a new procedure for expedited review of the validity of such business method patents. n

Washington ViewpointBy Ray Messina, Asst. General Counsel and Vice President for Government Relations, Discover

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price, access and delivery of traditional goods while creating entire new categories of digital goods, services and currencies for that matter. The pace of change will put a premium on the discipline required to filter new opportunities so that investments can be prioritized and risks can be mitigated. History offers a lot of valuable learning that can guide the next wave of prudent growth. The Internet era of the late ’90s taught many card issuers the perils of chasing every bright, shiny object thought to be the next big opportunity. There will be no shortage of new opportunities that are the rage in Silicon Valley and on

Wall Street because of sheer size and scalability. As is always the case, card industry growth will be determined by the value it creates for consumers on Main Street. nThe views expressed in the preceding article are those of First Annapolis, and do not necessarily reflect the views of Discover.

First Annapolis is a specialized management consulting firm serving the payments industry. One of the firm’s principal specialties is credit card issuing where it advises clients on strategic and tactical matters. Other practices include deposit access, merchant acquiring, retailer services, commercial payments and mobile/emerging payments. The firm also provides a suite of M&A advisory services and serves various international markets.

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If 2009, the year of the CARD Act, was the year of credit card regulation, and 2010, the year of the Antitrust Settlement and the Durbin Amendment, was the year of credit card regulation, then 2011 must also be the year of credit card regulation. Yes, there is a pattern here: New regulation will continue to be a major market mediator for the credit card industry.

Not only are new legal/regulatory challenges likely to be significant, they are likely to be unpredictable in scope. What we can see is a newly functional Consumer Financial Protection Bureau that, based on stated goals and initial hiring, is highly likely to provide continued tough scrutiny to credit cards, and in particular the terms and conditions, disclosures, and ongoing fine tuning of the CARD Act.

And don’t overlook the spillover effects of major changes in adjacent payment products. With the imminent release of debit interchange rules by the Federal Reserve, we will begin to understand the potential crossover implications for credit cards. How motivating will the new pricing be to merchants to steer consumers toward debit and away from credit? Overlay the

potential effects of the recent MasterCard®/Visa® antitrust settlement, and merchants may have considerable influence over which card the consumer pulls from his/her wallet, and ultimately over which cards consumers will find most valuable to possess.

The final lessons from 2010 and the Durbin Amendment are that significant card-pricing changes can emerge and be implemented quickly, and that interchange is in the crosshairs. Perhaps the changed political environment will slow further potential changes, and perhaps caution will prevail against major manipulations in credit pricing that might jeopardize the availability of consumer credit in a soft economy. But it is not easy to ignore the events of 2010 and the possibility of significant new regulatory initiatives that might further affect credit card issuing in 2011. n The views expressed in the preceding article are those of Mercator Advisory Group, and do not necessarily reflect the views of Discover.

Credit Issuing Outlook for 2011By Ken Paterson, VP Research Operations/Director, Credit Advisory Service, Mercator Advisory Group

Discover® has already achieved extensive card acceptance across the United States. At the same time, we have been expanding payment options throughout North America and the world. Reciprocal acceptance agreements with major international payment networks overseas are creating broad new opportunities for both our business partners and cardmembers. Our international presence has grown considerably with the acquisition of the Diners Club International® network and our numerous partnerships with foreign payment companies such as JCB, China UnionPay and our newest partner, the South Korea-based BCcard.

In 2008, Discover purchased Diners Club. To date, 97% of Diners Club volume in North America has been successfully moved onto the Discover Network. We have also enabled Discover card acceptance at Diners Club locations outside the U.S. in more than 43 countries. Prior to the agreements with China UnionPay in 2005 and JCB in 2006, Discover had very little presence outside North America.

Our recent alliance with BCcard will provide even more opportunities for both Discover and BCcard customers to access a broad range of merchants worldwide. BCcard is the largest

domestic network in South Korea. Its member banks have issued approximately 54 million cards.

The net effect of these agreements is that Discover is bringing to our merchant partners new customers and incremental sales volume. Discover Cardmembers also get to use their cards globally, and visitors to the U.S. can use cards issued by the new partner networks. Diane Offereins, executive vice president for payment services at Discover, stated, “All members can keep their local identity while having global acceptance.” We are confident that our aggressive brand-building will continue to result in more sales for Discover merchants around the world. n

International Expansion Broadens Discover® Acceptance

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There are benefits for both merchants and issuers with Private Label programs:

Merchant Value Drivers Issuer Value Drivers

• Customer loyalty• Customer communication • Higher approval rates than

co-brand• Turnkey simplicity• Brand exposure• Path to increased sales;

repeat visits• Revenue

• Leverage of brand loyalty• Marketing access to

merchant’s customers• Low-cost marketing channels• Engaged cardholders —

higher uptake, sales, loyalty• Cross-sell opportunities• Revenue — higher

revolve ratios

By implementing a Private Label Credit Card Program through Discover, speed to market can be streamlined and new features can also be added. For more information, please contact your relationship manager. n

Did You Know?Discover has an overall retail credit suite approach for their Private Label products:

If you have any article topics that you would like to see included in Horizon,SM please contact Thomas Laurent, Credit Issuance, at thomaslaurent@discover.com

One of the fastest growing forms of marketing in the U.S. is sponsorship of major events, particularly in the sports media arena. Much of their popularity stems from the fact that a sponsorship can offer the distinct advantage of achieving several marketing goals at once. More companies, such as Discover, are turning to new kinds of marketing tools like event sponsorship, which has proven to be an extremely successful way to build brand awareness.

Wide exposure in both electronic and print media can build brand visibility for any company. The kind of media coverage a sponsor may get is often far greater than in regular advertising so it can go a long way toward increasing brand awareness.

Discover has greatly expanded its brand presence through a growing list of high-profile sports sponsorships, including Notre Dame home games, the NHL All Star Game, the BCS and the Orange Bowl. Over 11 million people watched the Discover-branded Orange Bowl Game on TV, making it one of the top five most watched college football games in ESPN history.

In addition to sports sponsorships Discover is also increasing its brand presence by exposure to other events like the Wings Over Homestead Air Show, November 6 – 7, 2010, where over 400,000 people were in attendance. We are also working in many other ways to promote cardmember awareness, like

the recent Six Flags usage promotion that offered not only 5% discounts for using a Discover card, but also provided an exclusive cardmember entrance at the park.

Our current Discover Everyday Giveaway is also increasing visibility all during 2011 through a series of targeted promotions with grocery and drug stores from February through April, restaurants May through August, and travel and gas industries from September through December. In addition to the automatic entry every time cardmembers use their Discover card, they will receive 10 automatic entries in these categories for usage.

Our network-wide sweepstakes promotes excitement and awareness with 150 daily prizes of $25 Discover gift cards, monthly prizes of $25,000 plus $25,000 donated to a public school of the winning cardmember’s choice, and a one-time grand prize of $1,000,000.

Sponsorships, sweepstakes and special merchant promotions can be great tools for driving sales and incremental volume on the Discover network. Some of the visibility provided by these promotions and the new Discover sponsorships is far greater than any traditional form of advertising could ever provide — visibility that should translate into increased brand awareness at every level. n

Unique Promotions and Sponsorships Build Brand Awareness

Private Label Basic

Private Label Plus Co-brand

In-store spend only Full open spendIn-store spend plus complementary locations

Upcoming Industry Events • 23rd Annual Card Forum & Expo, April 27–29, 2011,

Fontainebleau, Miami Beach, FL

• National Association of Federal Credit Unions (NAFCU), 44th Annual Conference & Exhibition, June 28–July 2, 2011, Moscone West Convention Center, San Francisco, CA www.nafcu-annual.org

• ATPS/Co-Brand 2011, (Airline Travel Payments Summit), October 12–13, 2011, Hilton Toronto, Toronto, Canada

© 2011 DFS Services LLC