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investors or the Trusts. Changes in interest rates and other market See table below for sensitivities to changes in interest rates.
factors including credit spreads may result in a change in value of our INTEREST RATE RISK –PRIME ORIGINATIONS –At April 30, 2007, we
beneficial interest in Trusts and mortgage loans held for sale. had commitments to fund prime mortgage loans totaling $66.4 million.
We are impacted by changes in the market impacting loan sale prices We regularly enter into rate-lock commitments with our customers to
including interest rates, credit spreads and other factors. We are fund prime mortgage loans within specified periods of time. The fair
exposed to interest rate risk and credit spreads associated with value of rate-lock commitments is calculated based on the current
commitments to fund approved loan applications of $2.4 billion, subject market pricing of short sales of FNMA, FHLMC and GNMA mortgage-
to conditions and loan contract verification. In addition, we have backed securities and the coupon rates of the eligible loans. At April 30,
interest rate risk related to $169.9 million in new loan applications 2007, we recorded a liability with a fair value of $1.0 million related to
which have not yet been approved, and $425.0 million of applications rate-lock commitments.
which we expect to receive prior to our next anticipated change in rates We sell short FNMA, FHLMC and GNMA mortgage-backed securities
charged to borrowers. Of these amounts, we estimate only $1.6 billion to reduce the risk related to our prime commitments to fund fixed-rate
will likely be originated. prime loans. The position on certain, or all, of the fixed-rate mortgage
We use forward loan sale commitments, interest rate swaps and put loans is closed approximately 10-15 days prior to standard Public
options on Eurodollar futures to reduce our interest rate risk associated Securities Association (PSA) settlement dates. At April 30, 2007 we
with our commitment to fund non-prime loans. In addition, forward recorded an asset of $0.1 million related to these instruments.
loan sale commitments reduce our exposure to credit spreads. Changes To finance our prime originations, we use a warehouse facility with
in credit spread are derived from investor demand and competition for capacity up to $25.0 million, which bears interest at one-month LIBOR
available funds. Investor demand can be impacted by sector plus 140 to 200 basis points. As of April 30, 2007, the balance
performance and loan collateral performance. Sector performance outstanding under this facility was $0.4 million.
factors include the stability of the industry and individual competitors. RESIDUAL INTERESTS –Relative to modeled assumptions, an
Uncertainty regarding the ability of the industry as a whole to meet increase or decrease in interest rates would impact the value of our
repurchase obligations could impact credit spread demands by residual interests and could affect accretion income related to our
investors. Loan collateral performance or anticipated performance can residual interests. Residual interests bear the interest rate risk
m48
be driven by actual performance of the collateral or by market-related embedded within the securitization due to an initial fixed-rate period on
factors impacting the industry as a whole. Interest rate risk is managed the loans versus a floating-rate funding cost. Residual interests also bear
through the use of forward loan sale commitments, interest rate swaps the ongoing risk that the floating interest rate earned after the fixed
and put options on Eurodollar futures. Credit spread risk can be period on the mortgage loans is different from the floating interest rate
reduced using forward loan sale commitments. However, locking into on the bonds sold in the securitization.
these commitments eliminates the potential for price adjustments. We enter into interest rate caps and swaps to mitigate interest rate
Forward loan sale commitments represent our obligation to sell a risk associated with mortgage loans that will be securitized and residual
non-prime loan at a specific price in the future and increase in value as interests that are classified as trading securities because they will be
rates rise and decrease as rates fall. The Trusts may fulfill thesesold in a subsequent NIM transaction. The caps and swaps enhance the
obligations in response to the exercise of a put option by the third-party marketability of the securitization and NIM transactions. An interest
beneficial interest holders. At April 30, 2007, we had no forward loan rate cap represents a right to receive cash if interest rates rise above a
sale commitments. Forward loan sale commitments lock in the contractual strike rate, its value therefore increases as interest rates
execution price on the loans that will be ultimately delivered into a loan rise. The interest rate used in our interest rate caps and the floating rate
sale. used in swaps are based on LIBOR. At April 30, 2007 we had no assets
Interest rate swaps represent an agreement to exchange interest rate or liabilities recorded related to interest rate caps.
payments, whereby we pay a fixed rate and receive a floating rate. Put See table below for sensitivities to changes in interest rates for
options on Eurodollar futures represent the right to sell a Eurodollar residual interests and swaps. See Item 8, note 20 to the consolidated
futures contract at a specified price in the future. These swap and put financial statements for additional analysis of interest rate risk and
option contracts increase in value as rates rise and decrease in value as other financial risks impacting residual interests.
rates fall. At April 30, 2007, the interest rate swaps and put options It is our policy to use derivative instruments only for the purpose of
provided interest risk coverage of $3.1 billion. At April 30, 2007, we offsetting or reducing the risk of loss associated with a defined or
recorded $10.8 million in assets and $37.1 million in liabilities on our quantified exposure.
balance sheet related to changes in fair value of interest rate swaps and MORTGAGE SERVICING RIGHTS –Declining interest rates may cause
put options, respectively. increased refinancing activity, which reduces the life of the loans
H&R BLOCK 2007 Form 10K