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NOTE 9: DERIVATIVE INSTRUMENTS
A summary of our derivative instruments as of April 30, 2005 is as forward commitments at April 30, 2005 were $8.7 billion and
follows: $8.9 billion, respectively. Most of our forward commitments give
(in 000s) us the option to under- or over-deliver by five to ten percent.
We, in the normal course of business, enter into commitments
Asset (Liability) Gain (Loss) in the
Balance at April 30, Year Ended April 30, with our customers to fund both non-prime and prime mortgage
loans for specified periods of time at ‘‘locked-in’’ interest rates.
2005 2004 2005 2004 2003
These derivative instruments represent commitments to fund
Interest rate
loans (‘‘rate-lock equivalents’’). The fair value of non-prime loan
swaps $ (1,325) $– $ 47,192 $ (2,703) $ (5,194)
Interest rate caps 12,458 –(106) ––
commitments is calculated using a binomial option model. We
Rate-lock adopted SEC Staff Accounting Bulletin No. 105, ‘‘Application of
equivalents 801 (1,386) 2,187 (13,917) 6,158 Accounting Principles to Loan Commitments,’’ as of March 31,
Prime short sales (805) 2,080 (2,420) 4,663 (5,105) 2004. Upon adoption, we no longer record an asset for non-prime
$ 11,129 $ 694 $ 46,853 $ (11,957) $ (4,141) commitments to fund loans. The fair value of prime loan
commitments is calculated based on the current market pricing
We use interest rate swaps and forward loan sale commitments of short sales of FNMA, FHLMC and GNMA mortgage-backed
to reduce interest rate risk associated with non-prime loans. We securities and the coupon rates of the eligible loans.
generally enter into interest rate swap arrangements related to We sell short FNMA, FHLMC and GNMA mortgage-backed
existing loan applications with rate-lock commitments and, securities to reduce our risk related to our commitments to fund
beginning at the end of our second quarter, for rate-lock fixed-rate prime loans. The position on certain or all of the fixed-
commitments we expect to make in the next 30 days. Interest rate rate mortgage loans is closed approximately 10-15 days prior to
swaps represent an agreement to exchange interest rate standard Public Securities Association (‘‘PSA’’) settlement dates.
payments, effectively converting our fixed financing costs into a We entered into an agreement with Household (subsequently
floating rate. These contracts increase in value as rates rise and acquired by HSBC) during fiscal year 2003, whereby we waived
decrease in value as rates fall. our right to purchase any participation interests in and receive
We enter into interest rate caps to mitigate interest rate risk license fees relating to RALs during the period January 1 through
associated with mortgage loans that will be securitized and April 30, 2003. In consideration for waiving these rights, we
residual interests that are classified as trading securities because received a series of payments from Household, subject to certain
they will be sold in a subsequent NIM transaction. The caps adjustments based on delinquency rates on RALs made by
enhance the marketability of the securitization and NIM Household through December 31, 2003. This adjustment
transactions. An interest rate cap represents a right to receive provision was accounted for as a derivative and was marked-to-
cash if interest rates rise above a contractual strike rate, its value market monthly through December 31, 2003. Accordingly, during
therefore increases as interest rates rise. The interest rate used in fiscal year 2004, we recognized $6.5 million of revenues related to
our interest rate caps is based on LIBOR. this instrument. The final settlement in accordance with this
We enter into forward loan commitments to sell our non-prime agreement was received in January 2004.
mortgage loans to manage interest rate risk. Forward loan sale None of our derivative instruments qualify for hedge
commitments for non-prime loans are not considered derivative accounting treatment as of April 30, 2005 and 2004.
instruments and are therefore not recorded in our financial
statements. The notional value and the contract value of the
H&R BLOCK 2005 Form 10K
64