HR Block 2006 Annual Report Download - page 89

represents our residual interest in the ultimate expected outcome from of those assumptions. See Item 7A for sensitivity analysis related to
the disposition of the loans by the Trusts. The relative fair value of the interest rates.
MSRs and the beneficial interest in Trust is determined using discounted VALUATION OF MORTGAGE SERVICING RIGHTS –MSRs are carried
cash flow models, which require various management assumptions, at the lower of cost or fair value. We use discounted cash flow models
limited by the ultimate expected outcome from the disposition of the to determine the estimated fair values of our MSRs. Fair values take into
loans by the Trusts (see discussion below in ‘‘Valuation of Residual account the historical prepayment activity of the related loans and our
Interests’’ and ‘‘Valuation of Mortgage Servicing Rights’’). The following is estimates of the remaining future cash flows to be generated through
an example of a hypothetical gain on sale calculation: servicing the underlying mortgage loans. Variations in our assumptions
(in 000s)
could materially affect the estimated fair values, which may require us
Acquisition cost of underlying mortgage loans $ 1,000,000 to record impairments.
Fair values:
Prepayment speeds are somewhat correlated with the movement of
Net proceeds $ 995,000
market interest rates. As market interest rates decline there is a
Beneficial interest in Trusts 20,000
corresponding increase in actual and expected borrower prepayments
MSRs 7,000
as customers refinance existing mortgages under more favorable
$ 1,022,000
interest rate terms. This in turn reduces the anticipated cash flows
Computation of gain on sale:
associated with servicing resulting in a potential reduction, or
Net proceeds $ 995,000
impairment, to the fair value of the capitalized MSR. Prepayment rates
Less allocated cost ($995,000/$1,022,000 ×$1,000,000) 973,581
are estimated based on historical experience and third-party market
Recorded gain on sale $ 21,419
sources. Many non-prime loans have a prepayment penalty in place for
Recorded beneficial interest in Trusts
the first two to three years, which has the effect of making prepayment
($20,000/$1,022,000 ×$1,000,000) $ 19,570
speeds more predictable, regardless of market interest rate movements.
Recorded value of MSRs ($7,000/$1,022,000 ×$1,000,000) $ 6,849
If actual prepayment rates prove to be higher than the estimate made by
management, impairment of the MSRs could occur.
Variations in the assumptions we use affect the estimated fair values MSRs valued at $272.5 million and $166.6 million were recorded as of
and the reported gains on sales. Gains on sales of mortgage loans April 30, 2006 and 2005, respectively. See Item 8, note 1 to our
totaled $575.4 million, $772.1 million and $915.6 million for fiscal years consolidated financial statements for our methodology used in
2006, 2005 and 2004, respectively. stratifying and valuing MSRs. See Item 8, note 5 to our consolidated
See discussion in ‘‘Off-Balance Sheet Financing Arrangements’’ financial statements for current assumptions and a sensitivity analysis
related to the disposition of the loans by the Trusts and subsequent of those assumptions.
securitization by the Company. VALUATION OF GOODWILL –Our goodwill impairment analysis is
VALUATION OF RESIDUAL INTERESTS –We use discounted cash based on a discounted cash flow approach and market comparables,
flow models to determine the estimated fair values of our residual when available. This analysis, at the reporting unit level, requires
interests. We develop our assumptions for expected credit losses, significant management judgment with respect to revenue and expense
prepayment speeds, discount rates and interest rates based on historical forecasts, anticipated changes in working capital, and the selection and
experience and third-party market sources. Variations in our application of an appropriate discount rate. Changes in the projections
assumptions could materially affect the estimated fair values, which or assumptions could materially affect fair values. The use of different
may require us to record impairments or unrealized gains. In addition, assumptions would increase or decrease estimated discounted future
variations will also affect the amount of residual interest accretion operating cash flows and could effect our conclusions regarding the
recorded on a monthly basis. Available-for-sale (AFS) residual interests existence or amount of potential impairment.
valued at $159.1 million and $205.9 million were recorded as of April 30, Our goodwill balance was $1.1 billion as of April 30, 2006 and
2006 and 2005, respectively. We recorded $35.3 million in net write-ups $1.0 billion as of April 30, 2005. No goodwill impairments were
in other comprehensive income and $34.1 million in impairments in the identified during fiscal years 2006, 2005 or 2004.
income statement related to these residual interests during fiscal year LITIGATION –Our policy is to routinely assess the likelihood of any
2006 as actual performance differed from our assumptions. See Item 8, adverse judgments or outcomes related to legal matters, as well as
note 1 to our consolidated financial statements for our methodology ranges of probable losses. A determination of the amount of the
used in valuing residual interests. See Item 8, note 5 to our consolidated reserves required, if any, for these contingencies is made after
financial statements for current assumptions and a sensitivity analysis thoughtful analysis of each known issue and an analysis of historical
experience in accordance with Statement of Financial Accounting
H&R BLOCK 2006 Form 10K
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