HR Block 2012 Annual Report Download - page 37

REPRESENTATION AND WARRANTY CLAIMS
SCC has accrued a liability for estimated contingent losses related to representation and warranty claims as of
April 30, 2012 of $130.0 million, which represents SCC’s estimate of the probable loss that may occur. Losses on
claims reviewed and deemed to be valid totaled $16.2 million, $12.2 million and $18.2 million for fiscal years
2012, 2011 and 2010, respectively. These amounts were recorded as reductions of SCC’s accrued representation
and warranty liability.
During the second and fourth quarters of fiscal year 2012, SCC observed an increase in third-party activity. As
a result of this third-party activity, SCC’s estimate of probable claims increased from its prior expectations,
resulting in additional loss provisions of approximately $56 million. These loss provisions were partially offset
by changes in assumptions, including a decrease in the rate at which claims have been found to be valid,
corresponding to recent trends in reviewed claims, and a decrease in expected future claims related to net
interest margin (NIM) bonds that had matured, resulting in a net recorded loss provision in discontinued
operations of $20.0 million.
See additional discussion in Item 1A, “Risk Factors,” “Critical Accounting Estimates” below and in Item 8,
note 18 to the consolidated financial statements.
CRITICAL ACCOUNTING ESTIMATES
We consider the estimates 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 estimates are described in the following
paragraphs. We have reviewed and discussed each of these estimates with the Audit Committee of our Board of
Directors. For all of these estimates, we caution that future events rarely develop precisely as forecasted and
estimates routinely require adjustment and may require material adjustment.
See Item 8, note 1 to the consolidated financial statements, which discusses accounting estimates we have
selected when there are acceptable alternatives and new or proposed accounting standards that may affect our
financial reporting in the future.
MORTGAGE LOAN REPRESENTATION AND WARRANTY CLAIMS – 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.
Representations and warranties related to borrower fraud in whole loan sale transactions to institutional
investors, which represented approximately 68% of the disposal of loans originated in calendar years 2005, 2006
and 2007, included a “knowledge qualifier” limiting SCC’s liability to those instances where SCC had knowledge
of the fraud at the time the loans were sold. Representations and warranties made in other sale transactions did
not include a knowledge qualifier as to borrower fraud. In the event that there is 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 or 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
amount of claims received varies from period to period, and these variances have been and are expected to
continue to fluctuate substantially. Although there is no certainty regarding future claims volume, SCC may
continue to experience an increase in representation and warranty claims as a result of volatility in mortgage
delinquency rates, housing prices and expected expiration of applicable statutes of limitations and
developments in securities litigation and other proceedings to which SCC is not a party.
SCC accrues a liability for contingent losses relating to representation and warranty claims by estimating
probable losses for those claims, both known and projected, based on, among other things, historical validity
and severity rates. Projections of future claims are based on an analysis that includes a review of the terms and
provisions of applicable agreements, the historical experience under representation and warranty claims and
third-party activity, which includes inquiries from various third-parties. SCC’s methodology for calculating this
liability also includes an assessment of the probability that individual counterparties (private label
securitization trustees on behalf of certificate holders, monoline insurers and whole-loan purchasers) will assert
future claims.
This accrued liability is included in accounts payable, accrued expenses and other current liabilities on the
consolidated balance sheets, and represents SCC’s estimate of losses from future representation and
H&R BLOCK 2012 Form 10K 23