HR Block 2008 Annual Report Download - page 53

Determining the allowance for credit losses for loans held for investment requires us to make estimates of losses
that are highly uncertain and requires a high degree of judgment. If our underlying assumptions prove to be
inaccurate, the allowance for loan losses could be insufficient to cover actual losses. If our estimates understate
probable losses inherent in the portfolio, this would result in additional expense. An additional 10% adverse
change in our assumptions related to frequency and severity would result in additional losses of $2.7 million and
$2.4 million, respectively.
MORTGAGE LOAN REPURCHASE OBLIGATION – OOMC records a liability relating to potential losses that could
be incurred upon fulfillment of its obligation to repurchase previously sold loans in connection with early payment
defaults or breaches of other representations and warranties. Mortgage loans OOMC originated were generally
sold in the secondary market in the form of a whole-loan sale or mortgage-backed security.
In whole-loan sale transactions, OOMC generally guarantees the first payment to the purchaser. If this payment
is not collected, it is referred to as an early payment default. In the event of an early payment default, purchasers of
OOMC’s loans have the right to require that OOMC repurchase the loan. OOMC has incurred significant losses
historically in connection with early payment default obligations, in particular during fiscal year 2007 and the first
three quarters of the fiscal year 2008. Given that loan originations ceased in January 2008, we do not expect
continuing risk of loss related to first payment defaults. Accordingly, OOMC has no liability recorded at April 30,
2008 relating to early payment defaults.
OOMC is also obligated to repurchase loans sold or securitized in the event of a breach of representations and
warranties it made to purchasers or insurers of such loans, or otherwise indemnify certain third-parties for losses
incurred by them. OOMC records a liability for contingent losses relating to representation and warranty claims by
estimating loan repurchase volumes and indemnification obligations for both known claims and projections of
expected future claims. Projections of future claims are based on an analysis that includes a combination of
reviewing historical repurchase trends, developing loss expectations on loans sold or securitized, and predicting
the level at which previously originated loans may be subject to valid claims regarding representation and
warranty breaches. For loans actually repurchased, OOMC incurs losses for the difference between the principal
amount of the loan (together with accrued interest) and the value realized upon resale of the loan or liquidation of
the property securing the loan. OOMC typically estimates the amount of future loss based on current market values
of loans OOMC recently sold or received bids for. The loss severity assumption increased during the fourth quarter
of fiscal year 2008, from 50% to 62%.
Based on an analysis as of April 30, 2008, OOMC estimated its liability for loan repurchase and indemnification
obligations pertaining to claims of breach of representation and warranties to be $243.1 million. To the extent that
valid claim volumes in the future exceed current estimates, or the value of mortgage loans and residential home
prices decline, future losses may be greater than these estimates and those differences may be significant. See
Item 8, note 17 to our consolidated financial statements.
LITIGATION – It is our policy to routinely assess the likelihood of any adverse judgments or outcomes related to
legal matters, as well as ranges of probable losses. Assessing the likely outcome of pending litigation, including the
amount of potential loss, if any, is highly subjective. Our estimates may differ from actual results due to difficulties
in predicting the outcome of jury trial, arbitration hearings, settlement discussions and related activity, predicting
the outcome of class certification actions and various other uncertainties.
A determination of the amount of the reserves required, if any, for these contingencies is made after thoughtful
analysis of each known issue and an analysis of historical experience in accordance with Statement of Financial
Accounting Standards No. 5, “Accounting for Contingencies,” and related pronouncements. Therefore, we have
recorded reserves related to certain legal matters for which we believe it is probable that a loss will be incurred
and the range of such loss can be estimated. With respect to other matters, we have concluded that a loss is only
reasonably possible or remote, or is not estimable and, therefore, no liability is recorded.
VALUATION OF GOODWILL – We test goodwill and other indefinite-life intangible assets for impairment
annually or more frequently if events occur or circumstances change which would, more likely than not, reduce
the fair value of a reporting unit below its carrying value. Our goodwill impairment analysis is based on a
discounted cash flow approach, and market comparables when available. This analysis, at the reporting unit level,
requires significant management judgment with respect to revenue and expense forecasts, anticipated changes in
working capital and the selection and application of an appropriate discount rate. Changes in projections or
assumptions could materially affect our estimate of reporting unit fair values. The use of different assumptions
would increase or decrease estimated discounted future operating cash flows and could affect our conclusions
regarding the existence or amount of potential impairment. Finally, strategic changes in our outlook regarding
reporting units or intangible assets may alter our valuation approach and could result in changes to our
conclusions regarding impairment.
H&R BLOCK 2008 Form 10K 33