The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated and combined financial statements and related notes included elsewhere in this quarterly report. This quarterly report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are based upon the current beliefs and expectations of our management and are subject to significant risks and uncertainties. Actual results may differ materially from those set forth in the forward-looking statements. These forward-looking statements speak only as of the date of this quarterly report, and there is no undertaking to update or revise them as more information becomes available. The following factors, among others, could cause actual results to differ materially from those set forth in the forward-looking statements: the actions and initiatives of current and potential competitors; our ability to manage credit risks and securitize our receivables at acceptable rates and under sale accounting treatment; changes in economic variables, such as the availability of consumer credit, the housing market, energy costs, the number and size of personal bankruptcy filings, the rate of unemployment and the levels of consumer confidence and consumer debt; the level and volatility of equity prices, commodity prices and interest rates, currency values, investments, other market fluctuations and other market indices; the availability and cost of funding and capital; access to U.S. debt and deposit markets; losses in our investment portfolio; the ability to increase or sustain Discover Card usage or attract new cardmembers and introduce new products or services; our ability to attract new merchants and maintain relationships with current merchants; our ability to successfully integrate the Diners Club International network and maintain relationships with network participants; material security breaches of key systems; unforeseen and catastrophic events; our reputation; the potential effects of technological changes; the effect of political, economic and market conditions and geopolitical events; unanticipated developments relating to lawsuits, investigations or similar matters; the impact of current, pending and future legislation, regulation and regulatory and legal actions, including the Federal Reserve Board's proposed amendments limiting or modifying certain credit card practices; our ability to attract and retain employees; the ability to protect our intellectual property; the impact of our separation from Morgan Stanley; the impact of any potential future acquisitions; investor sentiment; and the restrictions on our operations resulting from indebtedness incurred during our separation from Morgan Stanley. Additional factors that could cause our results to differ materially from those described below can be found under "Part I. Item 1A. Risk Factors" in our annual report on Form 10-K for the year ended November 30, 2007 and "Part II. Other Information - Item 1A. Risk Factors" in our quarterly report on Form 10-Q for the quarter ended May 31, 2008, filed with the SEC and available at the SEC's internet site (http://www.sec.gov).

Introduction and Overview

Discover Financial Services is 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 cards and prepaid cards as well as other financial products and services to qualified customers. We are also a leader in payment processing and related services for merchants and financial institutions. Our fiscal year ends on November 30 of each year.

We continue to increase acceptance of cards issued on our signature card network (the "Discover Network") among small and mid-sized merchants in the United States through agreements with third-party acquirers. The purchase of Diners Club International ("Diners Club"), completed on June 30, 2008, provides us with another strong brand name and continues our progress toward increasing acceptance worldwide. As we achieve interoperability between Diners Club and the Discover Network over the next two to three years, we expect Discover Network cardholders to be able to use their cards at merchants that accept Diners Club cards around the world, and Diners Club cardholders to be able to use their cards on the Discover Network in North America. The results of Diners Club are included in the Third-Party Payments segment.

Our primary revenues come from interest income earned on loan receivables, securitization income derived from the transfer of credit card loan receivables to securitization trusts and subsequent issuance of beneficial interests through securitization transactions, and fees earned from cardmembers, merchants and issuers. The

primary expenses required to operate our business 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).

Our business activities are funded primarily through the process of asset securitization, the raising of consumer deposits, and both secured and unsecured debt. In a credit card securitization, loan receivables are first transferred to the securitization trust, 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. These trusts are excluded from our consolidated and combined financial statements in accordance with accounting principles generally accepted in the United States ("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 our consolidated 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. See "-Accounting Treatment for Off-Balance Sheet Securitizations" below for information regarding proposed amendments to the accounting standards applicable to asset securitizations and see "-Outlook" below for a discussion of the current state of the securitization markets.

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.

Managed loan data is relevant because we service the securitized and owned loans, and the related accounts, in the same manner without regard to ownership of the loans. Therefore, 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.

Financial measures using managed data are non-GAAP financial measures. Whenever managed data is presented in this quarterly report, a reconciliation of the managed data to the most directly comparable GAAP-basis financial measure is provided. See "-GAAP to Managed Data Reconciliations."

Third Quarter Highlights

• During the third quarter of 2008, we experienced growth in revenues (net interest income plus other income) as a result of Discover Card volume, installment loan growth and strong transaction volume in

• The consumer credit environment continues to be challenging. The managed net charge-off rate for the quarter was 5.20% and the managed over 30 days delinquency rate was 3.85% at the end of the period. The owned charge-off rate and owned over 30 days delinquency rate were 4.76% and 3.58%, respectively, for the quarter. Additionally, the loan loss reserve rate increased to 4.41% in the quarter compared to 3.28% in the third quarter of 2007.

• We increased our liquidity reserve by $1.2 billion since May 31, 2008 to $9.6 billion. Growth in funding in the quarter was achieved primarily through our deposit gathering channels. Deposit balances grew by approximately $2.2 billion, with approximately half the growth coming from direct-to-consumer deposits. We also completed two securitization transactions resulting in proceeds of $1.2 billion during the quarter.

• On June 30, 2008, we purchased Diners Club for $168 million in cash, expanding our credit and debit payments business globally. At the end of the quarter, Diners Club is consolidated into our statement of financial condition, and two months of its operating results are included in our consolidated statements of income.

Outlook

Our financial results continue to be adversely impacted by the challenging consumer credit environment and capital market conditions, which began with declines in the housing markets, rising unemployment and the write-down of mortgage-related securities, and spread to other financial instruments and the financial markets more generally. We believe deterioration in the consumer credit environment in the United States has been driven primarily by decreased availability of credit to consumers, rising unemployment levels, declining housing prices and rising energy costs. We recorded higher provision for loan losses this quarter as a result of higher charge-offs, owned loan growth and in anticipation of higher future charge-off rates. We have been experiencing a trend of a greater percent of delinquent accounts flowing into later stages of delinquency and eventually into charge- off. Although our underwriting and portfolio management strategies and geographic diversity are designed to manage exposure to credit losses, the delinquency trend and continued challenges in the consumer credit environment are likely to lead to a higher charge-off rate.

Deterioration in the capital markets, which has caused many financial institutions to seek additional capital, merge with larger and stronger financial institutions and, in some cases, fail, has led to concerns by market participants about the stability of financial markets generally and the strength of counterparties. We believe these concerns have resulted in a contraction of available credit, even for the most credit-worthy borrowers. Historically, we have used the asset-backed securities market as an important source of funding. The continued disruption in the capital markets has resulted in higher costs of and reduced access to asset-backed securitization funding. Due to recent market events, the public asset-backed securitization market has not been available at volumes and pricing levels that would be attractive to us. Our last public asset-backed securitization transaction was on June 18, 2008. It is difficult to predict if or when securitization markets will return to historical capacity and pricing levels.

Our response to the disruptions in the securitization markets has been and we anticipate will continue to be increased utilization of brokered and direct-to-consumer deposit channels. As of August 31, 2008, we had total deposits of $27.0 billion. Our use of deposit funding is dependent upon consumers choosing to deposit funds with our banking subsidiary, Discover Bank, and the willingness of third-party brokers to sell our deposits to their customers. Future market developments, as well as changes in consumer and market perceptions, could impact our ability to maintain and increase our deposit funding levels. An inability to obtain deposit funding in the future would materially adversely affect our liquidity position, financial condition and funding costs.

We have approximately $2.6 billion in public asset-backed securities maturing during the fourth quarter of 2008. As the downturn in execution levels in the capital markets is expected to continue, we anticipate that some or all of the fourth quarter maturities will be funded through our deposit channels. This shift will result in higher levels of owned loan receivables, a related increase in allowance for loan losses and a greater reduction in the value of the interest-only strip receivable. We also have $1.5 billion of unutilized commitments from third-party commercial paper asset-backed conduits for securitization funding, including a $750 million conduit facility established in the third quarter.

The interest rate environment remains a challenge to our business. Since August 31, 2008, LIBOR has moved to significantly higher levels. If LIBOR remains elevated during the fourth quarter, we will experience higher interest expense on our off-balance sheet borrowings resulting in a reduction in our securitization income and a decline in the value of our interest-only strip receivable.

Our payments business continues to be an area of opportunity for us. Our payments business grew its transaction volume in the third quarter, which we expect to continue throughout the rest of this year and into next year, as this business continues to benefit from new and existing relationships with financial institutions. The addition of Diners Club enhances our opportunities in the global payments business. However, we will begin to incur interoperability and integration costs associated with Diners Club and, therefore, do not expect Diners Club to contribute to future results at the same level as in the third quarter.

Accounting Treatment for Off-Balance Sheet Securitizations

The Financial Accounting Standards Board ("FASB") has issued proposed amendments to 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"). Under the proposed amendment to Statement No. 140, the concept of a qualifying special purpose entity ("QSPE") has been eliminated. QSPEs are currently exempt from the consolidation provisions of FIN 46R and, as a result, amendments to that standard are being considered as well. Exposure Drafts for proposed amendments to each standard were issued on September 15, 2008, and each is subject to a 60-day public comment period. Based on comments it may receive and other considerations, the FASB may revise the amendments before issuing final guidance. The changes to these standards, if adopted as proposed, 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 August 31, 2008, may require us to add approximately $27 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. As proposed, each amended standard would become effective for us on December 1, 2009. For a discussion of certain risks to us associated with the proposed amendments, see the discussion under "Part II. Other Information-Item 1A. Risk Factors" in our quarterly report on Form 10-Q for the quarter ended May 31, 2008. In addition, a new FASB Staff Position, which will require additional disclosures for securitization activities prior to the effective date of the amendments to Statement No. 140 and FIN 46R, is expected to be effective for us as early as December 1, 2008. On September 15, 2008, the federal banking agencies issued a joint press release stating that they are evaluating the potential impact that these proposals could have on banking organizations' financial statements, regulatory capital, and other regulatory requirements.

Legislative and Regulatory Developments

The Federal Reserve Board has proposed significant amendments to regulations that would limit or modify 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. We do not know the content of the final amendments nor the resulting impact

from the amendments at this time. If the amendments are adopted as proposed, the amendments would have a material adverse effect on our results of operations. For a discussion of certain risks to us associated with the proposed amendments, see the discussion under "Part II. Other Information-Item 1A. Risk Factors" in our quarterly report on Form 10-Q for the quarter ended May 31, 2008. In September, the U.S. House of Representatives approved a bill that would impose restrictions similar to those proposed by the Federal Reserve Board, but Congress did not take final action on this legislation before adjourning.

The Federal Deposit Insurance Corporation has proposed amendments to the deposit insurance assessment rates. The proposed amendments are subject to a 30 day public comment period. If adopted as proposed, we would have to pay higher deposit insurance assessments.

* * *

The remaining discussion provides a summary of our results of operations for the three and nine months ended August 31, 2008 and 2007, as well as our financial condition at August 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 on the Discover Network and other consumer products and services, including installment loans, prepaid cards and other consumer lending and deposit products offered through our Discover Bank subsidiary.

Third-Party Payments. The Third-Party Payments segment includes the PULSE Network ("PULSE"), an automated teller machine, debit and electronic funds transfer network; Diners Club, a global payments network; and our third-party issuing business, which includes credit, debit and prepaid cards issued on the Discover Network by third parties.

The following table presents segment data on a managed basis and a reconciliation to a GAAP presentation (dollars in thousands):

                                                      Managed Basis                                        GAAP Basis
                                                       Third-Party                    Securitization
For the Three Months Ended              U.S. Card      Payments(1)       Total        Adjustment(2)          Total
August 31, 2008
Interest income                        $  1,637,588   $         662   $  1,638,250   $       (956,558 )   $    681,692
Interest expense                            534,870              17        534,887           (229,244 )        305,643

Net interest income                       1,102,718             645      1,103,363           (727,314 )        376,049
Provision for loan losses                   754,028              -         754,028           (389,190 )        364,838
Other income                                482,311          54,686        536,997            338,124          875,121
Other expense                               585,760          26,787        612,547                 -           612,547

Income from continuing operations
before income tax expense              $    245,241   $      28,544   $    273,785   $             -      $    273,785

August 31, 2007
Interest income                        $  1,626,214   $         594   $  1,626,808   $       (951,944 )   $    674,864
Interest expense                            703,024              -         703,024           (385,900 )        317,124

Net interest income                         923,190             594        923,784           (566,044 )        357,740
Provision for loan losses                   418,349              -         418,349           (272,522 )        145,827
Other income                                481,060          29,465        510,525            293,522          804,047
Other expense                               605,264          20,620        625,884                 -           625,884

Income from continuing operations
before income tax expense              $    380,637   $       9,439   $    390,076   $             -      $    390,076

For the Nine Months Ended
August 31, 2008
Interest income                        $  4,861,739   $       1,823   $  4,863,562   $     (2,907,005 )   $  1,956,557
Interest expense                          1,754,450              19      1,754,469           (796,137 )        958,332

Net interest income                       3,107,289           1,804      3,109,093         (2,110,868 )        998,225
Provision for loan losses                 1,962,633              -       1,962,633         (1,081,194 )        881,439
Other income                              1,539,796         126,087      1,665,883          1,029,674        2,695,557
Other expense                             1,754,685          67,030      1,821,715                 -         1,821,715

Income from continuing operations
before income tax expense              $    929,767   $      60,861   $    990,628   $             -      $    990,628

August 31, 2007
Interest income                        $  4,709,530   $       1,726   $  4,711,256   $     (2,786,530 )   $  1,924,726
Interest expense                          1,990,471              19      1,990,490         (1,118,137 )        872,353

Net interest income                       2,719,059           1,707      2,720,766         (1,668,393 )      1,052,373
Provision for loan losses                 1,268,674              -       1,268,674           (830,973 )        437,701
Other income                              1,497,367          89,395      1,586,762            837,420        2,424,182
Other expense                             1,779,750          61,733      1,841,483                 -         1,841,483

Income from continuing operations
before income tax expense              $  1,168,002   $      29,369   $  1,197,371   $             -      $  1,197,371

(1) Diners Club was acquired on June 30, 2008.

(2) The Securitization Adjustment column presents the effect of loan securitizations by recharacterizing as securitization income the portions of the following items that relate to the securitized loans: interest income, interest expense, provision for loan losses, discount and interchange revenue and loan fee revenues. Securitization income is reported in other income.

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

U.S. Card

The U.S. Card segment reported pretax income of $245.2 million for the three months ended August 31, 2008, down $135.4 million, or 36%, as compared to August 31, 2007. The decrease in pretax income was driven by higher provision for loan losses, which was partially offset by an increase in net interest income. Provision for loan losses increased $335.7 million, or 80%, as a result of higher net charge-offs and a higher reserve rate, each of which is reflective of current economic conditions and recent delinquency trends, as well as owned loan growth. Net interest income increased $179.5 million, or 19%, when compared to the same period in 2007, reflecting widening net interest margins benefiting from lower cost of funds as our borrowing costs declined as a result of the Federal Reserve's interest rate reductions in the first half of 2008 and amortization of balance transfer fees previously recorded in loan fee income. Other expenses decreased $19.5 million, or 3%, due to lower marketing expenditures, lower depreciation expense on information technology equipment and lower legal fees during the three months ended August 31, 2008, partially offset by higher compensation expenses. Other income was relatively flat as an increase in discount and interchange revenue was offset by the inclusion of balance transfer fee amortization in interest income beginning in the third quarter of 2008.

The U.S. Card segment reported pretax income of $929.8 million for the nine months ended August 31, 2008, down $238.2 million, or 20%, as compared to August 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 $694.0 million, or 55%, as a result of higher net charge-offs and a higher reserve rate, each of which is reflective of current economic conditions and recent delinquency trends, as well as owned loan . . .