HR Block 2009 Annual Report Download - page 30

Our effective tax rate for discontinued operations was 35.3% and 34.4% for the fiscal years 2008 and 2007,
respectively.
CRITICAL ACCOUNTING POLICIES
We consider the policies discussed below to be critical to understanding our financial statements, as they require
the use of significant judgment and estimation in order to measure, at a specific point in time, matters that are
inherently uncertain. Specific risks for these critical accounting policies are described in the following paragraphs.
We have reviewed and discussed each of these policies with the Audit Committee of our Board of Directors. For all
of these policies, we caution that future events rarely develop precisely as forecasted and estimates routinely
require adjustment and may require material adjustment.
ALLOWANCE FOR LOAN LOSSES – The principal amount of mortgage loans held for investment totaled
$821.8 million at April 30, 2009. We are exposed to the risk that borrowers may not repay amounts owed to us when
they become contractually due. We record an allowance representing our estimate of credit losses inherent in the
portfolio of loans held for investment at the balance sheet date. Determination of our allowance for loan losses is
considered a critical accounting policy because loss provisions can be material to our operating results,
projections of loan delinquencies and related matters are inherently subjective, and actual losses are
impacted by factors outside of our control including economic conditions, unemployment rates and
residential home prices.
We record a loan loss allowance for loans less than 60 days past due on a pooled basis. The aggregate principal
balance of these loans totaled $518.0 million at April 30, 2009, and the portion of our allowance for loan losses
allocated to these loans totaled $18.8 million. In estimating our loan loss allowance for these loans, we stratify the
loan portfolio based on our view of risk associated with various elements of the pool and assign estimated loss
rates based on those risks. Loss rates are based primarily on historical experience and our assessment of
economic and market conditions. Loss rates consider both the rate at which loans will become delinquent
(frequency) and the amount of loss that will ultimately be realized upon occurrence of a liquidation of collateral
(severity). Frequency rates are based primarily on historical migration analysis of loans to delinquent status.
Severity rates are based primarily on recent broker quotes or appraisals of collateral. Because of imprecision and
uncertainty inherent in developing estimates of future credit losses, in particular during periods of rapidly
declining collateral values or increasing delinquency rates, our estimation process during fiscal year 2009 included
development of ranges of possible outcomes. Ranges were developed by stressing initial estimates of both
frequency and severity rates. Stressing of frequency and severity assumptions is intended to model deterioration in
credit quality that is difficult to predict during declining economic conditions. Future deterioration in credit quality
may exceed our modeled assumptions.
Mortgage loans held for investment include loans originated by our affiliate, SCC, and purchased by HRB Bank.
We have greater exposure to loss with respect to this segment of our loan portfolio as a result of historically higher
delinquency rates. Therefore, we assign higher frequency rate assumptions to SCC-originated loans compared
with loans originated by other third-party banks as we consider estimates of future losses. At April 30, 2009 our
weighted-average frequency assumption was 10.6% for SCC-originated loans compared to 1.3% for remaining loans
in the portfolio.
Loans 60 days past due are considered impaired and are reviewed individually. We record loss estimates
typically based on the value of the underlying collateral. Our specific loan loss allowance for these impaired loans
reflected an average loss severity of approximately 38.5% at April 30, 2009. The aggregate principal balance of
loans 60 days past due or more totaled $143.1 million at April 30, 2009, and the portion of our allowance for loan
losses allocated to these loans totaled $55.2 million.
Modified loans that meet the definition of a troubled debt restructuring (TDR) are also considered impaired and
are reviewed individually. We record impairment equal to the difference between the principal balance of the loan
and the present value of expected future cash flows discounted at the loan’s effective interest rate. However, if we
assess that foreclosure of a modified loan is probable, we record impairment based on the estimated fair value of
the underlying collateral. The aggregate principal balance of TDR loans totaled $160.7 million at April 30, 2009, and
the portion of our allowance for loan losses allocated to these loans totaled $10.1 million.
The loan loss allowance as a percent of mortgage loans held for investment was 10.23% at April 30, 2009,
compared to 4.49% at April 30, 2008. The loan loss provision increased significantly during the current year
primarily as a result of declining collateral values due to lower residential home prices and modeled expectations
for future loan delinquencies in the portfolio. The residential mortgage industry has experienced significant
adverse trends for an extended period. If adverse trends continue for a sustained period or at rates worse than
modeled by us, we may be required to record additional loan loss provisions, and those losses may be significant.
26 H&R BLOCK 2009 Form 10K