HR Block 2007 Annual Report Download - page 60

lower servicing costs, in particular interest paid to bondholders on actual loan pool performance, could cause additional adjustments to the
monthly loan prepayments, and higher discount rates. These changes in fair value of these residual interests and could cause changes to the
assumptions increased the weighted average value of MSRs recorded accretion of these residual interests in future periods.
during fiscal year 2006 by approximately $37.0 million (9 basis points of Loan servicing revenues increased $125.9 million, or 46.1%, compared
total retained MSRs of 61 basis points) over the prior year. to the prior year. The increase reflects a higher loan servicing portfolio
To mitigate the risk of short-term changes in market interest rates resulting from our loan origination growth. The average servicing
related to our loan originations and beneficial interest in Trusts, we use portfolio for the year increased 37.9%, to $75.6 billion, even with lower
interest rate swaps and forward loan sale commitments. We generally volumes in our sub-servicing business. The weighted average rate
enter into interest rate swap arrangements related to existing loan earned on our entire servicing portfolio was 38 basis points for fiscal
applications with rate-lock commitments and for rate-lock year 2006, compared to 36 basis points in the prior year.
commitments we expect to make in the next two to three weeks. During Total expenses for fiscal year 2006 increased $197.6 million, or 25.2%,
fiscal year 2006, we recorded a net $141.2 million in gains, compared to from the prior year. Cost of services increased $98.2 million, or 38.7%,
$46.9 million in the prior year, related to our interest rate swaps and mainly as a result of a higher average servicing portfolio during the
other derivative instruments. This increase was primarily due to rising current quarter year and increased amortization of MSRs.
short-term interest rates and an increase in the average notional amount Cost of other revenues increased $88.3 million over fiscal year 2005,
of swap arrangements to $8.4 billion in fiscal year 2006, compared to and includes a $12.6 million restructuring charge associated with the
$2.4 billion in fiscal year 2005. closing of some of our branch offices. Compensation and benefits
In fiscal year 2006, we completed sales of available-for-sale residual increased $53.8 million primarily due to an increase in the average
interests and recorded a gain of $31.5 million. These sales accelerated number of sales associates during the year to support higher loan
cash flows from these residual interests, effectively realizing previously volumes and the resulting increase in origination-based incentives,
recorded unrealized gains included in other comprehensive income. Wecoupled with $6.7 million in severance charges recorded as part of the
recorded a gain of $15.4 million in the prior year on a similar restructuring. Occupancy expenses increased $7.8 million primarily due
transaction. to $5.9 million in lease termination costs recorded as part of the
During fiscal year 2006, our available-for-sale residual interests restructuring. Other expenses increased $26.8 million primarily as a
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performed better than expected in our internal valuation models, with result of $20.1 million in additional interest expense related to mortgage
lower credit losses than originally modeled, partially offset by higher loans held on our balance sheet and $5.0 million of additional
than expected interest rates. We recorded favorable pretax mark-to- depreciation and amortization of our origination and servicing software.
market adjustments, which increased the fair value of these residual Selling, general and administrative expenses increased $11.0 million
interests $53.3 million during the year. These adjustments were primarily due to $15.3 million in additional marketing expenses,
recorded, net of write-downs of $18.0 million and deferred taxes of $5.1 million in additional occupancy costs and $3.2 million in higher
$13.5 million, in other comprehensive income and will be accreted into allocated shared services. These increases were partially offset by a
income throughout the remaining life of those residual interests. $15.7 million decline in compensation and benefits resulting from
Offsetting this increase were impairments of $34.1 million, which were reductions in administrative and corporate headcount and lower bonus
recorded in gains on sales of mortgage assets. Future changes in accruals.
interest rates or other assumptions, based on market conditions or Pretax income decreased $173.2 million, or 35.3%, for fiscal year 2006.
CRITICAL ACCOUNTING POLICIES
We consider the policies discussed below to be critical to understanding financial statements. Additional discussion of our recognition of gains
our financial statements, as they require the use of significant judgment on sales of mortgage assets follows.
and estimation in order to measure, at a specific point in time, matters VALUATION OF MORTGAGE LOANS HELD FOR INVESTMENT –
that are inherently uncertain. Specific risks for these critical accounting Determining the allowance for credit losses for loans held for
policies are described in the following paragraphs. For all of these investment requires us to make estimates of losses that are highly
policies, we caution that future events rarely develop precisely as uncertain and requires a high degree of judgment.
forecasted, and estimates routinely require adjustment and may require We record an allowance representing our estimate of credit losses
material adjustment. inherent in our portfolio of loans held for investment at the balance
REVENUE RECOGNITION –We have many different revenue sources, sheet date. The majority of our estimated credit loss is evaluated for
each governed by specific revenue recognition policies. Our revenue mortgage loans on a pooled basis. We stratify the loan portfolio based
recognition policies can be found in Item 8, note 1 to our consolidated on our view of risk associated with various elements of the pool and
H&R BLOCK 2007 Form 10K