Mortgage Meltdown Tapping H&R Block Reserves

(MoneyWatch)  Should you itemize or take the standard deduction? H&R Block will figure out which will get you a larger refund. What I am more interested in deciphering is why the nation's largest tax service provider is being hurt by the real-estate meltdown. I originally thought the company had limited its future exposure to the downward spiral in real-estate markets after selling its former mortgage servicing business (Option One) to WL Ross for approximately $1.3 billion in May 2008.

Although it no longer services or originates mortgages, H&R Block is required to indemnify WL Ross for any potential losses made due to deception or warranty breaches by its former mortgage subsidiary. In the first-quarter 2009 ended July 31, anticipating future recourse for bad loans the company added about $203 million to its reserves, according to the company's 10-Q filing.

In addition, the Option One sale was contingent on H&R Block re-purchasing almost $735 million in mortgage loans from its former affiliate. Held for investment, these loans comprised approximately 71 percent of the total $869 million in principal balances still held as of July 31. Mortgages more than 30-days past due accounted for 9.6 percent of this investment balance, up 617 basis points from last year.

Mortgages with a principal balance of $65.8 million were more than 180-days delinquent and considered as "in-substance foreclosures." A continuing erosion of home market values will likely increase the number of folks walking away from their equity loans. H&R Block is known for guaranteeing the accuracy of its tax preparation services. Increases in loss reserves and asset writedowns -- errors in judgment I wasn't expecting from a company that branded Peace of Mind services.

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This post first appeared on BNET's 10-Q Detective, by David Phillips.