HR Block 2012 Annual Report Download - page 27

preparation and filing alternatives. Continued high unemployment levels may negatively impact our ability to
increase or retain tax preparation clients.
Economic conditions that negatively affect housing prices and the job market may result in
deterioration in credit quality of our loan portfolio primarily held by HRB Bank, and such
deterioration could have a negative impact on our business and profitability.
The overall credit quality of mortgage loans held for investment is impacted by the strength of the U.S. economy
and local economic conditions, including residential housing prices. Economic trends that negatively affect
housing prices and the job market could result in deterioration in credit quality of our mortgage loan portfolio
and a decline in the value of associated collateral. Future interest rate resets could also lead to increased
delinquencies in our mortgage loans held for investment. Trends in the residential mortgage loan market
continue to reflect high loan delinquencies and lower collateral values. We recorded loan loss provisions
totaling $24.1 million, $35.6 million and $47.8 million during fiscal years 2012, 2011 and 2010, respectively.
HRB Bank’s loan portfolio is concentrated in the states of Florida, New York and California, which
represented 19%, 18% and 13%, respectively, of HRB Bank’s total mortgage loans held for investment at April 30,
2012. No other state held more than 10% of HRB Bank’s loan balances. If adverse trends in the residential
mortgage loan market continue, particularly in geographic areas in which HRB Bank owns a greater
concentration of mortgage loans, HRB Bank could incur additional significant loan loss provisions.
Mortgage loans purchased from Sand Canyon Corporation, previously known as Option One Mortgage
Corporation (including its subsidiaries, collectively, SCC) represent 59% of total loans held for investment at
April 30, 2012. These loans have experienced higher delinquency rates than other loans in HRB Bank’s portfolio,
and may expose HRB Bank to greater risk of credit loss.
In addition to mortgage loans, we also extend secured and unsecured credit to other clients, including
providing EAs to our tax clients. We may incur significant losses on credit we extend, which in turn could
reduce our profitability.
RISKS RELATING TO DISCONTINUED OPERATIONS
SCC is subject to potential contingent losses related to representation and warranty claims,
which may have an adverse effect on our cash flows, financial condition and results of
operations. Additionally, SCC has accrued an estimated liability related to these contingent
losses that may not be adequate.
SCC remains exposed to losses relating to mortgage loans it previously originated. Mortgage loans originated by
SCC were sold either as whole-loans to single third-party buyers or in the form of residential mortgage-backed
securities (RMBSs).
In connection with the sale of loans and/or RMBSs, SCC made certain representations and warranties. These
representations and warranties varied based on the nature of the transaction and the buyer’s or insurer’s
requirements, but generally pertained to the ownership of the loan, the validity of the lien securing the loan,
borrower fraud, the loan’s compliance with the criteria for inclusion in the transaction, including compliance
with SCC’s underwriting standards or loan criteria established by the buyer, ability to deliver required
documentation, and compliance with applicable laws. In the event there is deemed to be a breach of a
representation and warranty and such breach materially and adversely affects the value of a mortgage loan, or a
securitization insurer’s interest or a certificate holder’s interest in the mortgage loan, SCC may be obligated to
repurchase the loan or may otherwise indemnify certain parties for losses, referred to as “representation and
warranty claims.” The statute of limitations for a contractual claim to enforce a representation and warranty
obligation is generally six years or such shorter limitations period that may apply under the law of a state where
the economic injury occurred. SCC believes that the limitations period begins to run from the applicable closing
date of the sale of the loans or RMBS, although there is limited case law on this issue.
SCC accrues a liability for contingent losses relating to representation and warranty claims by estimating
probable losses for those claims, both known and projected. At April 30, 2012, SCC’s accrued liability for
representation and warranty claims was $130.0 million. SCC’s accrued liability is subjective and based upon,
among other things, SCC’s historical and projected frequency of representation and warranty claims. Losses
incurred in connection with actual or projected representation and warranty claims may be in excess of the
accrued liability. The accrued liability may need to be increased in the future for additional losses associated
with representation and warranty claims. If losses related to future representation and warranty claims are in
excess of SCC’s accrued liability, those losses could have a material adverse effect on our cash flows, financial
H&R BLOCK 2012 Form 10K 13