HR Block 2007 Annual Report Download - page 63

estimated life of the underlying loans. MSRs are carried at the lower of refinance existing mortgages under more favorable interest rate terms.
cost or market (LOCOM). On a quarterly basis, MSRs are assessed to As prepayment speeds increase, anticipated cash flows will generally
determine if our carrying value exceeds fair value. Fair value is decline resulting in a potential reduction, or impairment, to the fair
estimated using a discounted cash flow approach by stratifying the value of the capitalized MSRs. Alternatively, an increase in market
MSRs based on underlying loan characteristics, including the calendar interest rates may cause a decrease in prepayment speeds, and an
year the loans are sold. To the extent fair value is less than carrying increase in fair value of MSRs. Many of our loans include prepayment
value we record an impairment charge and adjust the carrying value of penalties during the first two to three years. Prepayment penalties tend
the MSRs. to lower prepayment speeds during the early life of our loans,
A market price of our MSRs is not readily available because non- regardless of market interest rate movements, therefore decreasing the
prime MSRs are not actively traded in the marketplace. Therefore, the sensitivity of expected prepayment speeds to changes in interest rates.
fair value of our MSRs is estimated using a discounted cash flow Prepayment speeds are estimated based on historical experience.
approach, using valuation methods and assumptions we believe Changes are made as necessary to ensure such estimates reflect current
incorporate assumptions used by market participants. Certain of these market conditions specific to our individual MSR stratas.
assumptions are subjective and require a high level of management Discount rates are determined by reviewing market rates used by
judgment. MSR valuation assumptions are reviewed and approved by market participants. These rates may vary based on economic factors
management on a quarterly basis. In determining the assumptions to be such as market perception of risk and changes in the risk-free interest
used to value MSRs, we review the historical performance of our MSRs, rates. Changes are made as necessary to ensure such estimates reflect
including back-testing of the performance of certain individual current market conditions for MSR assets.
assumptions (comparison of actual results to those expected). In Costs to service includes the cost of processing loan payments,
addition, we periodically review third-party valuations of certain of our making payments to bondholders, collecting delinquent accounts and
MSRs and peer group MSR valuation surveys to assess the administrative foreclosure activities. Market trends and changes to
reasonableness of our valuation assumptions and resulting fair value underlying expenses are evaluated to determine if updates to
estimates. assumptions are necessary. The economic factors affecting costs to
Critical assumptions used in our discounted cash flow model include service include unemployment rates, the housing market and the cost of
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mortgage prepayment speeds, discount rates, costs to service and labor. Higher unemployment rates may lead to higher delinquency and
ancillary income. Variations in our assumptions could materially affect foreclosure rates resulting in higher costs to service loans. The housing
the estimated fair values. Changes to our assumptions are made when market, including home price appreciation rates, impacts sale prices for
current trends and market data indicate that new trends have homes in foreclosure and our borrowers’ ability to refinance or sell their
developed. Certain assumptions, such as ancillary interest income, may properties in the event that they can no longer afford their homes, thus
change from quarter to quarter as market conditions and projected impacting delinquencies and foreclosures.
interest rates change. Other assumptions, such as expected prepayment Ancillary fees and income include late charges, non-sufficient funds
speeds, discount rates and costs of servicing may change less frequently fees, collection fees and interest earning funds held in deposit. These
as they are less sensitive to near-term market conditions. fees could be impacted by state legislation efforts, customer behavior,
Prepayment speeds may be affected by economic factors such as fee waiver policies and industry trends.
home price appreciation, market interest rates, the availability of other During the period from May 1, 2005 to April 30, 2007, assumptions
credit products to our borrowers and customer payment patterns. used in valuing MSRs were updated. The significant changes and their
Prepayment speeds include the impact of all borrower prepayments impact, both in dollars and basis points of loans sold during the quarter
including full payoffs, additional principal payments and the impact of of initial implementation, are outlined below beginning with the most
loans paid off due to foreclosure liquidations. As market interest rates recent changes.
decline, prepayment speeds will generally increase as customers
H&R BLOCK 2007 Form 10K