HR Block 2005 Annual Report Download - page 82

GAINS ON SALES OF MORTGAGE ASSETS ⬎⬎⬎ We sell estimated fair values, which may require us to record
substantially all of the non-prime mortgage loans we originate to impairments or unrealized gains. In addition, variations will also
the Trusts, which are qualifying special purpose entities affect the amount of residual interest accretion recorded on a
(‘‘QSPEs’’), with servicing rights generally retained. Prime monthly basis. Residual interests valued at $205.9 million and
mortgage loans are sold in whole loan sales, servicing released, to $211.0 million were recorded as of April 30, 2005 and 2004,
third-party buyers. Gains on sales of mortgage assets are respectively. We recorded $95.9 million in net write-ups in other
recognized when control of the assets is surrendered (when loans comprehensive income and $12.2 million in impairments in the
are sold to Trusts) and are based on the difference between cash income statement related to our residual interests during fiscal
proceeds and the allocated cost of the assets sold. year 2005 as actual performance differed from our assumptions.
We determine the allocated cost of assets sold based on the See Item 8, note 1 to our consolidated financial statements for
relative fair values of cash proceeds, MSRs and the beneficial our methodology used in valuing residual interests. See Item 8,
interest in Trusts, which represents the ultimate expected note 6 to our consolidated financial statements for current
outcome from the Trusts’ disposition of the loans. The relative assumptions and a sensitivity analysis of those assumptions. See
fair value of the MSRs and the beneficial interest in Trust is Item 7A for sensitivity analysis related to interest rates.
determined using discounted cash flow models, which require VALUATION OF MORTGAGE SERVICING RIGHTS ⬎⬎⬎ MSRs
various management assumptions, limited by the ultimate are carried at the lower of cost or fair value. We use discounted cash
expected outcome from the disposition of the loans by the Trusts flow models to determine the estimated fair values of our MSRs.
(see discussion below in ‘‘Valuation of Residual Interests’’ and Fair values take into account the historical prepayment activity of
‘‘Valuation of Mortgage Servicing Rights’’). The following is an the related loans and our estimates of the remaining future cash
example of a hypothetical gain on sale calculation: flows to be generated through servicing the underlying mortgage
loans. Variations in our assumptions could materially affect the
(in 000s)
estimated fair values, which may require us to record impairments.
Acquisition cost of underlying mortgage loans $ 1,000,000 Prepayment speeds are somewhat correlated with the
Fair values:
Net proceeds $ 990,000 movement of market interest rates. As market interest rates
Beneficial interest in Trusts 20,000 decline there is a corresponding increase in actual and expected
MSRs 9,000 borrower prepayments as customers refinance existing
$ 1,019,000 mortgages under more favorable interest rate terms. This in turn
Computation of gain on sale: reduces the anticipated cash flows associated with servicing
Net proceeds $ 990,000 resulting in a reduction, or impairment, to the fair value of the
Less allocated cost ($990,000/$1,019,000 ×$1,000,000) 971,541 capitalized MSR. Prepayment rates are estimated based on
Recorded gain on sale $ 18,459 historical experience and third-party market sources. Many non-
Recorded beneficial interest in Trusts prime loans have a prepayment penalty in place for the first two
($20,000/$1,019,000 ×$1,000,000) $ 19,627 to three years, which has the effect of making prepayment speeds
Recorded value of MSRs ($9,000/$1,019,000 ×$1,000,000) $ 8,832 more predictable, regardless of market interest rate movements.
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 MSRs valued at $166.6 million and $113.8 million were
values, which would affect the reported gains on sales. Gains on recorded as of April 30, 2005 and 2004, respectively. See Item 8,
sales of mortgage loans totaled $772.1 million, $915.6 million and note 1 to our consolidated financial statements for our
$792.1 million for fiscal years 2005, 2004 and 2003, respectively. methodology used in stratifying and valuing MSRs. See Item 8,
See discussion in ‘‘Off-Balance Sheet Financing Arrangements’’ note 6 to our consolidated financial statements for current
related to the disposition of the loans by the Trusts and assumptions and a sensitivity analysis of those assumptions.
subsequent securitization by the Company. VALUATION OF GOODWILL ⬎⬎⬎ Our goodwill impairment
VALUATION OF RESIDUAL INTERESTS ⬎⬎⬎ We use analysis is based on a discounted cash flow approach and market
discounted cash flow models to determine the estimated fair comparables, when available. This analysis, at the reporting unit
values of our residual interests. We develop our assumptions for level, requires significant management judgment with respect to
expected losses, prepayment speeds, discount rates and interest revenue and expense growth rates, changes in working capital,
rates based on historical experience and third-party market and the selection and application of an appropriate discount rate.
sources. Variations in our assumptions could materially affect the
H&R BLOCK 2005 Form 10K
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