HR Block 2012 Annual Report Download - page 38

warranty claims where assertion of a claim and a related contingent loss are both determined to be probable
and reasonably estimable. Because, among other things, the rate at which future claims may be determined to
be valid and actual loss severity rates may differ significantly from historical experience, SCC is not able to
estimate reasonably possible loss outcomes in excess of its current accrual. A 1% increase in both assumed
validity rates and loss severities would result in losses beyond SCC’s accrual of approximately $31 million. This
sensitivity is hypothetical and is intended to provide an indication of the impact of a change in key assumptions
on the representation and warranty claims liability. In reality, changes in one assumption may result in changes
in other assumptions, which could affect the sensitivity and the amount of losses.
While SCC uses what it believes to be the best information available to it in estimating its liability, assessing
the likelihood that claims will be asserted in the future and estimating probable losses are inherently subjective
and require considerable management judgment. To the extent that the volume of asserted claims, the level of
valid claims, the counterparties asserting claims, the nature and severity of claims, remedies claimed, or the
value of residential home prices, among other factors, differ in the future from current estimates, future losses
may differ from the current estimates and those differences may be significant.
See Item 8, note 18 to the consolidated financial statements.
LITIGATION AND RELATED CONTINGENCIES – 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. A determination
of the amount of the liability required to be accrued, if any, for these contingencies is made after analysis of
each known issue and an analysis of historical experience. Therefore, we have accrued liabilities 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 reasonably estimated. With respect to other matters, we have concluded that a loss is only reasonably
possible or remote, or is not reasonably estimable and, therefore, no liability is accrued.
Assessing the likely outcome of pending litigation, including the amount of potential loss, if any, is highly
subjective. Our judgments on whether a loss is probable, reasonably possible or remote and our estimates of
probable loss amounts may differ from actual results due to difficulties in predicting the outcome of jury trials,
arbitration hearings, settlement discussions and related activity, predicting the outcome of class certification
actions and numerous other uncertainties. Due to the number of claims which are periodically asserted against
us, and the magnitude of damages sought in those claims, actual losses in the future may significantly differ
from our current estimates. We are subject to threatened litigation claims and indemnification claims, which are
described in Item 8, note 19 to the consolidated financial statements.
ALLOWANCE FOR LOAN LOSSES – The principal amount of mortgage loans held for investment totaled
$429.3 million at April 30, 2012. We are exposed to the risk that borrowers may not repay amounts owed to us
when they become contractually due. We record an allowance representing our estimate of probable credit
losses in the portfolio of loans held for investment at the balance sheet date. Determination of our allowance for
loan losses is considered a critical accounting estimate because loss provisions can be material to our operating
results, projections of loan delinquencies and related matters are inherently subjective, and actual losses are
impacted by factors outside of our control including economic conditions, unemployment rates and residential
home prices.
We record a loan loss allowance for loans less than 60 days past due on a pooled basis. The aggregate
principal balance of these loans totaled $248.8 million at April 30, 2012, and the portion of our allowance for
loan losses allocated to these loans totaled $9.2 million. In estimating our loan loss allowance for these loans,
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. Loss rates consider both the rate at which loans will become
delinquent (frequency) and the amount of loss that will ultimately be realized upon occurrence of a liquidation
of collateral (severity). Frequency rates are based primarily on historical migration analysis of loans to
delinquent status. Severity rates are based primarily on recent broker quotes or appraisals of 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 includes
development of ranges of possible outcomes. Ranges were developed by stressing initial estimates of both
frequency and severity rates. 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.
Mortgage loans held for investment include loans originated by our affiliate, SCC, and purchased by HRB
Bank. We have greater exposure to loss with respect to this segment of our loan portfolio as a result of
24 H&R BLOCK 2012 Form 10K