HR Block 2008 Annual Report Download - page 52

Loan servicing revenues decreased $79.5 million, or 18.3%, compared to the prior year. The decrease reflects a
decline in the average servicing portfolio throughout the year, which decreased 15.9%, to $60.0 billion. The decline
in the average servicing portfolio is the result of a decline in the subservicing portfolio, coupled with significantly
lower origination volumes, due to our decision to exit the origination business. OOMC sold its servicing portfolio
as of April 30, 2008.
Total expenses for fiscal year 2008 decreased $554.9 million, or 42.4%, from the prior year. Cost of services
decreased $112.7 million primarily due to lower amortization of mortgage servicing rights (MSRs).
Cost of other revenues decreased $91.7 million, primarily due to the termination of origination activities. As a
result, compensation and benefits declined due to lower staffing levels, although this reduction was partially offset
by increased interest expense.
Selling, general and administrative expenses were flat compared to the prior year, as restructuring and
termination activities recorded in the current year were offset by lower operating expenses resulting from
prior year restructuring activities.
The loss from discontinued operations for the current year of $763.1 million is net of tax benefits of
$412.8 million, and primarily includes income tax benefits related to OOMC.
FISCAL 2007 COMPARED TO FISCAL 2006 – Conditions in the non-prime mortgage industry were challenging
throughout fiscal year 2007, and particularly in our fourth quarter. OOMC’s mortgage operations, as well as the
entire industry, were impacted by deteriorating conditions in the secondary market, where reduced investor
demand for loan purchases, higher investor yield requirements and increased estimates for future losses reduced
the value of non-prime loans. Under these conditions, non-prime originators generally reported significant
increases in losses and many were unable to meet their financial obligations.
The pretax loss for fiscal year 2007 was $1.2 billion compared to income of $316.9 million in fiscal year 2006. The
pretax loss of $1.2 billion includes losses of $50.2 million from our Business Services and Tax Services
discontinued operations, with the remainder from our mortgage business. Mortgage results include
$388.7 million in loss provisions and repurchase reserves, impairments of residual interests of $168.9 million
and impairments of other assets totaling $345.8 million.
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.
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.
VALUATION OF MORTGAGE LOANS HELD FOR INVESTMENT – We record an allowance representing our
estimate of credit losses inherent in the portfolio of loans held for investment by HRB Bank at the balance sheet
date. The majority of this estimated credit loss is evaluated for mortgage loans on a pooled basis. 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. We review non-performing loans, including loans meeting the definition of
troubled debt restructurings, individually and record loss estimates typically based on the value of the underlying
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 2008 included development of ranges of possible outcomes. Ranges were developed by stressing initial
estimates of both the rate at which loans in HRB Bank’s portfolio will become delinquent (frequency) and the
amount of loss HRB Bank will ultimately realize upon occurrence of a liquidation of collateral (severity). 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.
The loan loss reserve as a percent of mortgage loans held for investment was 4.49% at April 30, 2008, compared
to 0.25% at April 30, 2007. The loan loss provision increased significantly during the current year as a result of
declining collateral values due to lower residential home prices, increasing delinquencies occurring in our
portfolio during fiscal year 2008, and modeled expectations for future deterioration 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, HRB Bank may be required to record
additional loan loss provisions, and those losses may be significant.
32 H&R BLOCK 2008 Form 10K