HR Block 2007 Annual Report Download - page 87

assumptions used in estimating the cash flows are based on evaluation breaches of other representations and warranties customary to the
of the historical experience of the servicing portfolio, the mortgage banking industry.
characteristics of the applicable loan portfolio, as well as also taking Loans are repurchased due to a combination of factors, including
into consideration the current and expected economic and interest rate delinquency and other violations of representations and warranties. In
environment and its expected impact. The estimated cash flows are whole loan sale transactions, we guarantee the first payment to the
discounted at an interest rate we believe an unaffiliated third-party purchaser. If this payment is not collected, it is referred to as an early
purchaser would require as a rate of return on a financial instrument payment default.
with a similar risk profile. We evaluate, and adjust if necessary, the fair For early payment default-related losses, the amount of losses we
values of residual interests quarterly by updating the actual expect to incur depends primarily on the frequency of early payment
performance and expected assumptions in the discounted cash flow defaults, the rate at which defaulted loans subsequently become current
models based on current information and events and by estimating, or on payments (‘‘cure rate’’), the propensity of the buyer of the loans to
validating with third-party experts, if necessary, what a market demand recourse under the loan sale agreement and the severity of loss
participant would use in determining the current fair value. To the incurred on loans which have been repurchased. The frequency of early
extent that actual excess cash flows are different from estimated excess payment defaults, cure rates and loss severity may vary depending on
cash flows, the fair value of the residual would increase or decrease. the creditworthiness of the borrower and economic factors such as
BENEFICIAL INTEREST IN TRUSTS–TRADING. The beneficial home price appreciation and interest rates. To the extent actual losses
interest in Trusts is recorded as a result of daily non-prime loan sales to related to repurchase activity are different from our estimates, the fair
Trusts. We hold an interest in the Trusts equal to the difference between value of our repurchase reserve will increase or decrease. See note 20
the fair value of the assets and the cash proceeds, adjusted for under ‘‘Commitments and Contingencies.’’
contractual advance rates, received from the Trusts. The beneficial REVENUE RECOGNITION. Gains on sales of mortgage assets are
interest is classified as a trading security, based on management’s recognized when control of the assets is surrendered (when loans are
intentions, is carried at fair value with changes in fair value recorded in sold to Trusts) and are based on the difference between cash proceeds
the consolidated income statements. Fair value is calculated as the and the allocated cost of the assets sold, including any guarantees or
present value of estimated future cash flows, limited by the ultimate repurchase reserves. Other components of gain on sales of mortgage
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expected outcome from the disposition of the loans by the Trusts. These loans include gains or losses on derivatives, loan sale repurchase
assets are included in noncurrent assets held-for-sale on the reserves, impairments and direct origination and acquisition expenses.
consolidated balance sheets. Interest income consists primarily of interest earned on mortgage
MORTGAGE SERVICING RIGHTS. Mortgage servicing rights (MSRs) loans and accretion income. Accretion income represents interest
retained in the sale of mortgage loans are recorded at allocated carrying earned over the life of residual interests using the effective interest
amounts based on relative fair values at the time of the sale. The MSRs method.
are carried at the lower of cost or fair value. Fair values of MSRs are Service revenues consist of mortgage loan servicing fees and are
determined based on the present value of estimated future cash flows recorded in the period in which the service is performed.
related to servicing loans. Assumptions used in estimating the value of DERIVATIVE ACTIVITIES. We use forward loan sale commitments,
MSRs include market discount rates and anticipated prepayment speeds interest rate swaps and other financial instruments to manage our
including default, estimated ancillary fee income, estimated third-party interest rate risk related to commitments to fund mortgage loans and
servicing costs and other economic factors. The prepayment speeds are mortgage loans underlying our beneficial interest in Trusts. We do not
estimated using our historical experience and third-party market enter into derivative transactions for speculative or trading purposes.
sources. The MSRs are amortized to earnings in proportion to, and over We record derivative instruments as assets or liabilities, measured at
the period of, estimated net future servicing income. MSRs are reviewed fair value. None of our derivative instruments are designated for hedge
quarterly for potential impairment. Impairment is assessed based on the accounting treatment as of April 30, 2007 or 2006. Gains or losses on
fair value of each risk stratum. MSRs are stratified by the vintage year, derivative instruments are presented in our consolidated statements of
which approximates date of origination, loan type, primarily 2- and 3- income and statements of cash flows in a manner consistent with the
year adjustable and fixed rate, and loans with and without prepayment earnings effect of the economically hedged item.
penalties. These securities are included in noncurrent assets held-for- LITIGATION –Our policy is to routinely assess the likelihood of any
sale on the consolidated balance sheets. adverse judgments or outcomes related to legal matters, as well as
REPURCHASE RESERVES. Our repurchase reserves relate to potential ranges of probable losses. A determination of the amount of the
losses that could be incurred related to the repurchase of sold loans or reserves required, if any, for these contingencies is made after
indemnification of losses as a result of early payment defaults or thoughtful analysis of each known issue and an analysis of historical
H&R BLOCK 2007 Form 10K